Transcript class12

Welcome to
EC 382: International
Economics
By: Dr. Jacqueline Khorassani
Week Twelve
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Week Twelve: Class 1
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Tuesday, November 20
14:10-15:00
AC 202
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I received a mail
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
We are all under a lot of stress at the
moment and we were just wondering
if you had any hints for us for the
test??? It would be greatly
appreciated!
No
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Another question
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hi, i just want to clarify the chapters
for the exam. 1-8, 11,13,14,15. so
that means we don't have to study
chapters 9,10 and 12???
Yes, you are right.
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By the way
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Expect
Your last ICA tomorrow
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Recall the Law of One
Price
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Same goods have the same price in terms
of the same currency in different countries.
PU.S. = [R($/£)] * PU.K.
R = Exchange rate, number of dollars need to
get one Pound
PU.S. = Price of the good in U.S.
PU.K. = Price of the good in U.K.

Rearranging the equation we get:
[R($/£)] = PU.S./PU.K.
– Exchange rate between currencies
should be equal to ratio of prices.
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Purchasing Power
Parity (PPP)

Extends the law of one price to a market
basket of goods.
– Exchange rate between two countries
should equal the ratio of the price levels
in those countries.
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PPP Example

If the price level in U.S. increases
relative to the price level in U.K.
– U.S. imports of U.K. goods increase
and exports would decrease.
– Dollar would depreciate.
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PPP is a long-run concept
like the law of one price.
 Normally,
a country’s current
exchange rate is never equal
to its PPP value.
 But still it is a useful
benchmark
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Over valued /
Undervalued Currency
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If the value of a currency is above its
PPP level  overvalued
If the value of a currency is below its
PPP level  undervalued
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Absolute Purchasing Power
Parity
[R($/£)] = PU.S./PU.K.

PU.S. and PU.K. now refer to the
price of a particular market basket
of tradable goods.
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Example

If PU.S. = $1000 and PU.K. = £500
– then the exchange rate is
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
$2/Pounds
If prices doubled in the U.S. but were
unchanged in U.K.,
– then the PPP exchange rate
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would move to $4/Pound
PPP exchange rate rises to offset the dollar’s
lower purchasing power.
The exchange rate may change in nominal
terms, but the real value of goods
purchased is the same.
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Relative Purchasing Power Parity
%XR  %PU .S .  %PU . K .
Example
 If U.S. inflation was 10% and
only 5% for the U.K. in one year
 the U.S. dollar would depreciate
by 5%
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There is not a lot of
empirical evidence for PPP
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1.
2.
Why?
How do different countries measure the
price level?
– CPI, GDP deflator, PPI
Even if they all go with CPI
 The baskets do not have the same goods
 The baskets have some non-tradable
goods & services
 The weight that each good has may not
be the same across nations
 Gasoline may have more weight in the
US basket than in the UK basket
 Less public transportation in US
 Longer distances in US
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Now, we would like to

Wish Luke Barry
a very happy
birthday.
From: Frank (the Tank) Crowe
& the rest of us
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Recap
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PPP suggests that nominal exchange
rates depend on the relative price
levels
But what affects the price levels?
– demand for goods and services
– supply of goods and services
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The role of money
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Let’s express demand for money this
way
MD = k * P * Y
Y is our real income (real GDP)
P * Y is our nominal income (nominal GDP)
k is the proportion of nominal income held
as money
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When money market is in
equilibrium
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MD = MS
SO
MS = k * P * Y
Solving for P
P = MS/k*Y
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In US & UK
PUS = MSUS / kUS * YUS
PUK = MSUK / kUK * YUK
Taking a ratio of these equations we can get
Price ratio between the U.S. and U.K.
PUS
MSUS kUK YUK

*
*
PUK
MSUK kUS YUS
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International Economics

Week Twelve –Class 2
– Wednesday, November 21
– 11:10-12:00
– Tyndall
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
On line grades are up to date
– Check your
ID numbers
 grades
 and let me know if there is an error
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OCA is graded and available
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OCA1
Key to Question 1
Each part had 2 points.
Visit the WTO’s web page at wto.org to answer the following
questions:
a)
Is Iran a member of WTO? How about Iraq?
•
b)
No & No
Which country is the newest member of WTO?
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c)
Tonga
Is the following statement true or false? Explain. “WTO is for
free trade at any cost.”
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d)
False; “It’s really a question of what countries are willing to bargain
with each other, of give and take, request and offer.”
Is the following statement true or false? Explain. “The voting
power of a nation that is a member of WTO depends on its
GDP.”
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e)
False; each member has one vote.
What was the size of the WTO’s budget last year?
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175 million Swiss francs
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Question 2 had 10 points
Search the web (or elsewhere) for at least
two examples of countervailing and/or
antidumping duties imposed by the U.S. in
the recent years. Name the products and
their exporting countries and the nature of
the imposed duties. Clearly list your
sources.
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How will I figure your
assignment grade?
1.
2.
3.
4.
We had a total of 6 assignments
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4 had 6 points each
1 had 10 points
1 had 20 points
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Example: If you received 3 out of 6 on one
assignment, I will record 10 out of 20
I will convert all to 20 points assignments
I will drop the lowest grade
Add up the rest
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Max = 100 points
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My Request
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1.
2.
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Go to my website at
www.marietta.edu/~khorassj
Click on Let me hear from you
Choose EC382: International Economics
Answer the following questions
What were the strengths of this course
and/or the instructor?
What were the weaknesses of this
course and/or the instructor?
Be as specific as you can please.
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I did not receive any
questions from you
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
1.
2.
We will cancel this afternoon’s class
Instead
Keep on sending your questions to
me.
I will post the answer to general
questions and those questions that
come to me via anonymous feedback
on line on my website.
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Long run relationship between
nominal exchange rate, money
supply, real GDP and more
PUS MSUS k UK YUK
R($ / £) 

*
*
PUK MSUK kUS YUS
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PUS MSUS k UK YUK
R($ / £) 

*
*
PUK MSUK k US YUS
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If money supply rises faster in US
than in UK
– Prices will grow faster in US than in UK
– UK residents buys fewer US goods
– UK residents buy fewer dollars
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Dollar depreciates in the long run
Pound appreciates in the long run
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R($ / £) 
PUS
MSUS k UK YUK

*
*
PUK
MSUK k US YUS
If the proportion of money people want to
hold (k) increases in US.
•
•
•
•
•
Means that people want to hold on to money
instead of spending it
US Prices go down
UK residents would want to buy more US
goods
Dollar appreciates in the long run & pound
depreciates
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R($ / £) 
•
PUS
MSUS k UK YUK

*
*
PUK
MSUK k US YUS
If real GDP in US increases faster
than in UK
•
•
•
•
Means production in the US grew faster
To sell the extra goods, US prices go
down
UK residents buy more US goods
Dollar appreciates in the long run
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The Real Exchange Rate
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We observe nominal exchange rates – not real
exchange rates.
May assume that changes in nominal rates mean
foreign goods are necessarily cheaper in real
terms
Can make bad business decisions if consider only
nominal rates and not real exchange rates
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The Real Exchange Rate
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Real Exchange Rate (RXR):
– Relative price of two currencies after adjusting
for changes in domestic price within the two
countries
PU.K.
RXR ($ / £)  R($ / £) *
PU.S.
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Example
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The price levels are 50 and 100 in UK and US
respectively.
Nominal exchange rate is $3/£
What is real exchange rate?
PU.K.
RXR ($ / £)  R ($ / £) *
PU.S.
RXR  3$ / £ * (50 / 100)  1.5
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International Economics
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Week Twelve - Class 3
– Wednesday, November 21
– 15:10-16:00
– AC 201
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Class canceled
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