IAE Handout 6

Topic 6 - Exchange Rates Accounting and Economics
Introduction to Accounting
and Economics
Topic 6: Introducing the international
dimension
V2.0 © NCC Education Limited
Exchange Rates Topic 6 - 6.‹#›
Summary of Lecture
• Words you must know
• Foreign Currency
• The Markets for Foreign Currency
• Exchange Rates
• The Balance of Payments
• International Trade
V2.0 Visuals Handout – Page 1

Summary of Lecture
• Comparative Advantage
• Regulating World Trade
• Globalisation
• Review of the topic
Words you must know

Exchange Rate: The value at which two currencies
may be exchanged.
Foreign Exchange Market: The market where currencies may be

bought and sold.
The Balance of Payments: A set of accounts that records

transactions between a national
economy and the rest of the world.
International Trade: Trade between countries.

Foreign Currency
• UK= Pound Sterling
• USA= US dollar
• Much of continental Europe = Euro
• China = RMB
• Almost every country in the world has its

own currency.
Foreign Currency
International trade depends on the ability of
countries to change:
• Their domestic currency into foreign currency when

they import
• Foreign currency into their domestic currency when

they export

The Markets for Foreign

Currency
• There are foreign exchange markets in every country
• This is a market where one foreign currency is exchanged for

another
• An exchange rate is the price used to exchange currencies
• There is normally one rate if you are selling foreign currency

and buying the domestic currency
• Exchange rates will change from country to country
Exchange Rates
There is no such thing as a single exchange
rate. These rates will change depending upon:
• whether you are buying or selling foreign currency
• where you are in the world

Can governments influence

exchange rates?
• Yes
• They can apply fixed exchange rates or they can allow the
markets to set exchange rates (floating exchange rates)
• Governments can also use reserves of foreign currency

(foreign exchange reserves) to buy and sell domestic
currency on the domestic foreign exchange market in order to
influence exchange rates
The Balance of Payments

• Governments are exactly like businesses in
that they must keep accounting records
• Records of transactions between one

country and the rest of the world


• The UK records the balance of payments (the net cash flows)
with the rest of the world
• The current account of the balance of payments accounts

records trade between the UK and other countries
• Trade can be ‘visible’

- It can be related to trading products such as cars and food.
• Trade can also be ‘invisible’

- It can be related to services
- In the UK this generally relates to banking and insurance
services

• The capital account of the balance of payments
account records things like:
- money received from the European Union for
infrastructure projects
- money transferred by migrants
• The financial account of the balance of payments

records international sales and purchases of
financial assets such as stocks and shares

International Trade
• We live in a global economy
• Countries have become specialists, which

means that they supply the rest of the world
with the goods and services that they
produce the most efficiently
Comparative Advantage
• Economists talk about the law of
comparative advantage
• This law states that countries specialise in

the production of goods that they produce
at a lower cost than other countries

Comparative Advantage
Why does comparative advantage occur?
• Differences in technology between countries
• Differences in productivity of labour
• Differences in management skills. This will affect

production efficiency, design, and the management
of the supply chain
Regulating World Trade

• In general terms the world gains from international
trade, but there can be situations where some
countries can lose out
• In the last 20 years we have seen a decline in jobs

in the manufacturing industry in the UK
• Workers in the UK have lost jobs, whereas workers

in countries like China have gained jobs, as a result
of international trade


• Governments often like to intervene and try
to regulate world trade
• One way of doing this is to introduce tariffs

or taxes on imports

There are a number of arguments in favour of tariffs:
• Large economies (for example the USA) that

import a lot can force the world price for certain
products to increase. This will increase the price of
these goods for other countries
• A tariff imposed by the USA can be beneficial for

the rest of the world by reducing US demand for an
imported product and keeping the price of the
product low for other countries


• In countries where there are high levels of income
inequality, a reduction in the availability of luxury
goods can help preserve social stability
• Countries may wish to preserve domestic

industries for strategic reasons
• The possible threat of a future war can make

governments use tariffs to protect domestic
defence manufacturing, food manufacturing and
electricity supply companies

• Tariffs on imported goods can be used to
protect a way of life (e.g. craft workers or
agricultural workers)
• Tariffs can be used to suppress the

consumption of luxury goods. This can help
preserve social stability


There are also a number of arguments against tariffs:
• Tariffs distort international trade and do not allow the world to

benefit from comparative advantage
• Tariffs cause waste by protecting inefficient domestic

industries
• It slows the development of new technologies and production

methods

• The World Trade Organisation (WTO) was founded in 1995
• It is the organisation that coordinates trading agreements

between countries
• Its aim is to promote the free trading of goods between

countries
• The WTO has about 150 member countries that account for
97% of world trade


The organisation requires that its members
agree to a set of rules. The main rules are:
• Countries are not allowed to discriminate in favour

of or against other countries. Any trade agreement
that a country makes with another country must be
on the same terms as with all the members of the
WTO (exception = free trade areas such as the
European Union)

• Countries that benefit from a reduction in
tariffs granted by another country must
make similar tariff reductions itself
• Quotas (the restriction of trade by restricting

quantities of goods imported) are prohibited


• Competition between countries must be fair
• Tariffs must be changed only by negotiation with

trading partners
• The WTO also has a role in settling disputes

between member nations. It has the power to
impose sanctions on countries that break trading
agreements
Globalisation
• In economics, globalisation can be defined
as an “integration of national economies
into the international economy through
trade, foreign direct investment, capital
flows, migration and the spread of
technology”
Jagdish Bhagwati. (2004). In Defence of Globalisation.

Oxford: Oxford University Press.

Globalisation
Begg defines globalisation in more simple
terms as:
“the increase in cross-border trade and

influence on the economic and social
behaviour of nation states”.
Begg, D. (2006). Foundations of Economics, 3rd edition.

Cambridge: McGraw-Hill.
Arguments for Globalisation

• Consumers have access to a greater range of
products and services at higher quality and lower
cost
• Developing countries benefit from trade with richer

countries such as the USA
• Increasing international trade promotes political

stability in international affairs

Arguments against Globalisation

• Workers in developing countries are exploited by
multinational corporations
• Environmental damage is increased due to the

actions of companies and governments that ignore
controls on pollution
• Globalisation undermines the social and cultural

framework of developing countries
- The ideals of the consumer society are promoted at the
expense of local cultures
Globalisation
• What are the economic facts on

globalisation?
• Begg provides a useful chart of world

welfare indicators:

World Welfare Indicators
1820 1910 1950 1992
Average
income per
0.7 1.5 2.1 5.0
person (1990
$000)
World
population 1.1 1.7 2.5 5.5
(billion)
Number of
people
earning < 0.9 1.1 1.4 1.3
$1/day
(billion)
Source: Begg 2006:335 (adapted)
Globalisation
• It is clear that the average income per person has risen in line
with increased levels of international trade
• The values of income shown are in US dollars at 1990 prices
• The number of people earning less that $1 a day has

increased between 1820 and 1992, but then so has the
number of people
• In fact, between 1950 and 1992 the number of people earning

less that $1 a day has decreased slightly, while the world
population has more than doubled

Review of the Topic

• This topic has given you an overview of the
international economy and the factors that
affect how national economies function in
an international context
Topic 6
Any questions?

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Topic 6 - Exchange Rates Accounting and Economics

V2.0 © NCC Education Limited

Exchange Rates Topic 6 - 6.‹#›

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 1

Exchange Rates Topic 6 - 6.‹#›

V2.0 © NCC Education Limited

Exchange Rates Topic 6 - 6.‹#›

Words you must know

Foreign Exchange Market: The market where currencies may be

The Balance of Payments: A set of accounts that records

International Trade: Trade between countries.

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 2

Exchange Rates Topic 6 - 6.‹#›

• Almost every country in the world has its

V2.0 © NCC Education Limited

Exchange Rates Topic 6 - 6.‹#›

• Their domestic currency into foreign currency when

• Foreign currency into their domestic currency when

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 3

Exchange Rates Topic 6 - 6.‹#›

The Markets for Foreign

• This is a market where one foreign currency is exchanged for

• An exchange rate is the price used to exchange currencies

• There is normally one rate if you are selling foreign currency

• Exchange rates will change from country to country

V2.0 © NCC Education Limited

Exchange Rates Topic 6 - 6.‹#›

• whether you are buying or selling foreign currency

• where you are in the world

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 4

Exchange Rates Topic 6 - 6.‹#›

Can governments influence

• Governments can also use reserves of foreign currency

V2.0 © NCC Education Limited

Exchange Rates Topic 6 - 6.‹#›

The Balance of Payments

• Records of transactions between one

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 5

Exchange Rates Topic 6 - 6.‹#›

The Balance of Payments

• The current account of the balance of payments accounts

• Trade can be ‘visible’

• Trade can also be ‘invisible’

V2.0 © NCC Education Limited

Exchange Rates Topic 6 - 6.‹#›

The Balance of Payments

• The financial account of the balance of payments

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 6

Exchange Rates Topic 6 - 6.‹#›

• Countries have become specialists, which

V2.0 © NCC Education Limited

Exchange Rates Topic 6 - 6.‹#›

• This law states that countries specialise in

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 7

Exchange Rates Topic 6 - 6.‹#›

• Differences in technology between countries

• Differences in productivity of labour