1. How do individuals of one nation trade money with individuals of another nation?

People trade one currency for another in foreign exchange markets. It is not necessary for large traders to go to a specific place to conduct such transactions. They call a bank that deals in foreign currency and ask the bank to convert some of their dollars to the currency they want. The amount of foreign currency exchanged for dollars depends on the exchange rate—the price of one country’s money in terms of another.

2. How do changes in exchange rates affect international trade?

If the dollar appreciates against a foreign currency, you will get more of that currency per dollar. If the dollar depreciates against a foreign currency, you will get less of that currency per dollar. If a country’s currency appreciates in value, international demand for its products falls, all other things being equal. This is because that country’s goods become more expensive in terms of other currencies. If a country’s currency depreciates, the prices of its goods and services in terms of other countries’ currencies fall and international demand for its products increases.

3. How do nations record their transactions with the rest of the world?

The record of a nation’s transactions with the rest of the world is called its balance of payments. The balance of payments is divided into two categories: the current account and the capital account. The current account is the sum of the balances for merchandise, services, investment income, and unilateral transfers. The capital account records the transactions necessary to move these into and out of the country. The net balance in the balance of payments must be zero, so a deficit (or surplus) in the current account must be offset by a surplus (or deficit) in the capital account. A country becomes a larger net debtor (or smaller net creditor) if it shows a deficit in its current account (or surplus in its capital account).