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🌍 Unit 6 · Open Economy: International Trade & Finance 🏠 Unit Hub 🗂 Flashcards 🗺 Cheat Sheet ⭐ Essentials 🎨 Visual Review 📝 MC Practice ✎ FRQ Practice

AP Macroeconomics Unit 6 Essentials

The must-know terms and big ideas for Unit 6: Open Economy — International Trade and Finance. Every vocabulary word and concept you need to master.

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Big Idea 1
Exchange rates are prices, set by supply and demand
Once you see a currency as just another good being bought and sold, the entire foreign exchange market becomes an extension of Unit 1's supply-and-demand model. Anything that increases demand for a currency (more exports, higher interest rates, more foreign investment) makes it appreciate. Anything that increases supply (more imports, more outbound investment) makes it depreciate. There's no new logic here — just a new good.
Exchange Rates Foreign Exchange Market Supply & Demand
Big Idea 2
A stronger currency cuts both ways for trade
It's tempting to think a "strong" currency is always good news, but appreciation makes a country's exports more expensive for foreign buyers while making imports cheaper for domestic consumers. The net effect on net exports is usually negative — exporters lose competitiveness even as shoppers benefit from cheaper imported goods. This is why governments and central banks sometimes face real trade-offs when their policy choices move the exchange rate.
Appreciation Net Exports Trade-Offs
Big Idea 3
Capital flows and exchange rates are tightly linked
Currency markets don't just respond to trade in goods — they respond just as strongly to trade in financial assets. A country offering higher real interest rates attracts foreign capital seeking better returns, and that capital inflow requires buying the local currency first, pushing it to appreciate. This is the same mechanism that connects Unit 4's loanable funds market and Unit 5's crowding-out discussion to the international economy in Unit 6.
Capital Flows Interest Rates Financial Account
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Balance of payments
A record of all economic transactions between a country's residents and the rest of the world, composed mainly of the current account and the financial account.
Balance of Payments
Current account
Records trade in goods and services (net exports), net investment income, and net transfers.
Balance of Payments
Financial (capital) account
Records the net flow of financial assets — stocks, bonds, real estate, and other investments — between countries.
Balance of Payments
Current account deficit/surplus
A deficit means a country imports more (in goods, services, income, and transfers combined) than it exports; offset by a financial account surplus.
Balance of Payments
Foreign exchange market
The market in which currencies are bought and sold; supply and demand here determine exchange rates.
Exchange Rates
Exchange rate
The price of one currency in terms of another.
Exchange Rates
Appreciation
An increase in the value of one currency relative to another.
Exchange Rates
Depreciation
A decrease in the value of one currency relative to another.
Exchange Rates
Floating (flexible) exchange rate
An exchange rate determined entirely by market supply and demand, without government intervention.
Exchange Rates
Fixed exchange rate
An exchange rate set and maintained by a government or central bank at a specific level.
Exchange Rates
Determinants of currency demand
Foreign demand for a country's exports, relatively higher interest rates, and foreign investment in that country's assets.
Determinants
Determinants of currency supply
Domestic demand for imports and domestic investment in foreign assets.
Determinants
Purchasing power parity
The idea that exchange rates should adjust so that identical goods cost the same amount across countries when expressed in a common currency; relative inflation rates drive long-run exchange rate movements.
Determinants
Net exports (Xn)
Exports minus imports (X − M); a component of aggregate demand.
Trade Effects
Trade balance
The difference between the value of a country's exports and imports of goods and services.
Trade Effects
Tariff
A tax imposed on imported goods, raising their price and tending to reduce import quantity.
Trade Policy
Quota
A limit on the physical quantity of a good that can be imported.
Trade Policy
Capital flows
The movement of financial capital (investment funds) between countries, closely tied to relative real interest rates.
Capital Flows
Real interest rate parity (international)
The tendency for capital to flow toward countries offering relatively higher real interest rates, increasing demand for those countries' currencies.
Capital Flows