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Welcome to Econ 414 International Economics

Welcome to Econ 414 International Economics. Study Guide Week Thirteen. CHAPTER 13. Exchange Rates and Their Determination: A Basic Model. What is the exchange rate?. Value of one currency in terms of another currency Spot rate = rate for transaction on spot.

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Welcome to Econ 414 International Economics

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  1. Welcome to Econ 414 International Economics Study Guide Week Thirteen

  2. CHAPTER 13 Exchange Rates and Their Determination: A Basic Model

  3. What is the exchange rate? • Value of one currency in terms of another currency • Spot rate = rate for transaction on spot Is the exchange rate flow or stock?

  4. Has dollar appreciated or depreciated? • Yesterday the spot rate was €1 = $1.43 • Today the spot rate is €1 = $1.53 • Dollar has depreciated

  5. What is the rate of depreciation of dollar? %Δ = (1.43-1.53)* 100 /1.43 = -7% Dollar depreciated by 7%

  6. Euros per Dollar: What is causing these fluctuations?

  7. Average yearly exchange rate of euro • $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

  8. Demand and Supply ForcesAffect the Exchange Rate. • Foreign Exchange Market • Demand Curve • Shows the quantity demanded for a currency by residents of another country at different exchange rates. • Supply Curve • Shows the amount of a currency supplied at a different exchange rates.

  9. 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

  10. $/€ Demand for Euros € 1 € 2 € 3 euros The Demand for euro $3 $2 $1

  11. $/€ Euros Shifts: What if US GDP goes up? US income goes up  Demand D1 D1 Demand for euros D2

  12. International Economics • Week Ten –Class 2 • Wednesday, November 7 • 11:10-12:00 • Tyndall

  13. $/€ Euros Shifts: What if US Prices go down? Americans buy fewer European goods  Demand goes down D2 D1 Demand for euros D2

  14. $/€ Euros 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

  15. Consider supply of Euro by Europeans • 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

  16. $/€ euros The Supply of Euros Supply of Euros $3 $2 $1 €1 €2 €3

  17. $/€ S2 Supply of Euros S1 Euros Shifts: What if European’s income goes up? Europeans will want to buy more American goods  Supply of euro goes up to S1

  18. $/€ S2 Supply of Euros S1 Euros Shifts: What if Europeans expect euro to appreciate further in the near future? Europeans will supply less now Supply of euro goes down to S2

  19. 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.

  20. $/Euro Supply of Euros 2.5 2.0 1.5 Demand for Euros 100 200 300 400 500 Euros Equilibrium Exchange Rate

  21. $/Euro Supply of Euros 2.5 2.0 1.5 Demand for Euros 100 200 300 400 500 Euros What if Europe’s GDP goes up? Euro depreciates Supply of euro goes up to S1 S1

  22. $/Euro Supply of Euros 3.0 2.5 2.0 1.5 Demand for Euros 100 200 300 400 500 Euros What if US prices go up and EU prices don’t Euro appreciates Demand goes up because Americans would want to buy more European goods S1 Supply goes down because Europeans buy fewer American goods D1

  23. Are fluctuations in the value of a currency good or bad for the economy? • No surplus/ shortage • Good

  24. But fluctuations in the value of a currency discourages international trade or investment. • 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

  25. 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

  26. Fluctuating exchange rates have led to an industry of forecasters. • Need reasonably accurate forecasts for country’s • GDP • Inflation • Interest rate • The supply/demand model is good for general comments about exchange over the medium to long run.

  27. 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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