Transcript Study Guide 13

Welcome to Econ 414
International Economics
Study Guide
Week Thirteen
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CHAPTER 13
Exchange Rates
and Their Determination:
A Basic Model
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What is the exchange rate?
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Value of one currency in terms of
another currency
Spot rate = rate for transaction on spot
Is the exchange
rate flow or
stock?
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Has dollar appreciated or
depreciated?
• Yesterday the spot rate was
€1 = $1.43
• Today the spot rate is
€1 = $1.53
• Dollar has depreciated
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What is the rate of depreciation of
dollar?
%Δ in Spot Rate =
Beginning Rate - Ending Rate
* 100
Beginning Rate
%Δ = (1.43-1.53)* 100 /1.43
= -7%
Dollar depreciated by 7%
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Euros per Dollar: What is causing
these fluctuations?
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Average yearly exchange rate of
euro
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$1.0658 in 1999
$0.9236 in 2000
$0.8956 in 2001
$0.9456 in 2002
$1.1312 in 2003
$1.2439 in 2004
$1.2441 in 2005
$1.2556 in 2006
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Demand and Supply Forces
Affect the Exchange Rate.
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Foreign Exchange Market
1. Demand Curve
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Shows the quantity demanded for a
currency by residents of another
country at different exchange rates.
2. Supply Curve
•
Shows the amount of a currency
supplied at a different exchange
rates.
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Consider demand for euro by
Americans
• Why will Americans demand
euro?
• To import European goods and
services
• To buy European bonds/stocks
• To sell the euros later or in a
different location for profits
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The Demand for euro
$/€
$3
$2
$1
Demand
for Euros
€1
€2
€3
euros
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Shifts: What if US GDP goes up?
$/€
US income goes up 
Demand D1
D1
Demand for euros
D2
Euros
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International Economics
• Week Ten –Class 2
– Wednesday, November 7
– 11:10-12:00
– Tyndall
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Shifts: What if US Prices go
down?
$/€
Americans buy
fewer European
goods  Demand
goes down D2
D1
Demand for euros
D2
Euros
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Shifts: What if interest rates in
Europe go up?
$/€
US residents would
want to buy more
European bonds
Demand D1
D1
Demand for euros
D2
Euros
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Consider supply of Euro by
Europeans
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Why will Europeans supply euro?
To importers American goods and services
To buy American bonds/stocks
To sell later or in the different location for
profits
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The Supply of
Euros
$/€
Supply of
Euros
$3
$2
$1
€1
€2
€3
euros
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Shifts: What if European’s
income goes up?
$/€
Europeans will want to
buy more American
goods  Supply of
euro goes up to S1
S2
Supply of Euros
S1
Euros
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Shifts: What if Europeans expect
euro to appreciate further in the
will supply less now
near future? Europeans
Supply of euro goes down to S
2
$/€
S2
Supply of Euros
S1
Euros
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Equilibrium in the
Foreign Exchange Market
•
Equilibrium Exchange:
– The exchange rate where the quantity
demanded of foreign exchange equals the
quantity supplied.
•
In our examples, the amount of euros U.S.
residents want to buy equals the amount of euros
Europeans want to sell.
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Equilibrium Exchange Rate
$/Euro
Supply
of Euros
2.5
2.0
1.5
Demand
for Euros
100
200 300 400 500
Euros
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What if Europe’s GDP goes
up?
Euro
$/Euro
Supply of
euro goes up
to S1
depreciates
Supply
of Euros
2.5
S1
2.0
1.5
Demand
for Euros
100
200 300 400 500
Euros
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What if US prices go up
and EU prices don’t
Demand goes up
Euro
appreciates
because
Americans would
want to buy more
European goods
S1
$/Euro
Supply
of Euros
3.0
Supply
goes down
because
Europeans
buy fewer
American
goods
2.5
2.0
D1
1.5
Demand
for Euros
100
200 300 400 500
Euros
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Are fluctuations in the value of a
currency good or bad for the
economy?
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No surplus/ shortage
– Good
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But fluctuations in the value of a currency
discourages international trade or investment.
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I order a US car today for $30,000
Delivery and payment in 6 months
In 6 months, what if $ appreciates against euro?
I have to spend more euros than expected.
Uncertainty discourages international trade
– Bias toward trade within a nation
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But wait; there is a solution
• I can buy dollars in a forward market.
– Sign a contract today to buy $30,000 in six
months for €0.8 per dollar.
• There is a fee involved
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Fluctuating exchange rates have
led to an industry of forecasters.
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Need reasonably accurate
forecasts for country’s
– GDP
– Inflation
– Interest rate
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The supply/demand model is good
for general comments about
exchange over the medium to long
run.
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Asst 7: Due before 10:00 PM on
Saturday November 24
• Question 9, Page 316
• This is an individual assignment.
• Make sure to draw a separate graph for each
case.
• This Assignment has 20 points.
• Hey I know it is Thanksgiving.
– That is why I gave one extra day this time.
– Do it before thanksgiving.
– It is really short.
• Happy Thanksgiving
– Save some for me!!!!
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