Chapter 14

Question 1

Spot exchange rate

Answer 1

Current exchange rate of trading a currency for another currency.

It is the going rate when people want to exchange currency immediately or at the earliest possible date.

Question 2

Floating currency

Answer 2

Currency whose value fluctuates constantly depending on demand and supply for that currency.

Question 3

Fixed currency

Answer 3

Currency whose value is pegged to another currency by a monetary authority. (Very little deviation from that rate)

Ex: Saudi Riyal exchange rate to 1 US Dollar never changes from 3.75. (Only slightly)

Belize Dollar is pegged at 2 BZD to 1 USD. (Only slightly)

Question 4

Forward exchange rate

Answer 4

is the exchange rate at which a bank agrees to exchange one currency for another at a future date

Ex: You are set to receive a set of goods from a British company in 90 days, so you must pay in pounds. Since the dollar fluctuates against the pound, you want to lock in an exchange rate to facilitate the transaction. So, you will negotiate a deal with the bank to lock in a future exchange rate to exchange dollars for pounds once the goods arrive in 90 days.

Question 5

Shifters of currency demand

Answer 5

1. Demand for country’s goods leads to more demand for that nation’s currency and vice versa.
2. Relatively high real interest rates on interest-bearing assets leads to greater demand for currency to buy those assets compared to the country of the citizens demanding the currency (and vice versa) (Ex: Higher real interest in US assets compared to Mexico will lead to more demand for USD from Mexicans)
3. Future expected exchange rates (direct relationship with demand)
4. Relatively high inflation compared to country in question will decrease demand and vice versa (Ex: Mexicans will demand less US goods if inflation is relatively higher there than in Mexico)

Question 6

Shifters of currency demand and supply between two countries

Answer 6

1. If there’s greater demand for country A’s goods, then demand for country A’s currency will increase from country B and the supply of country B’s currency will increase. Country A currency will appreciate while country B’s will depreciate. Vice versa.
2. If real interest rates for interest-bearing assets (like bonds and money market securities) are higher in Country A than in Country B, then demand for Country A currency from Country B will increase while supply for Country B’s currency will increase. Country A currency will appreciate while Country B’s will depreciate. Vice versa.
3. Relatively high inflation in country A to country B will lead to the opposite effects as #2.
4. When people in country B believe a currency, or assets in a country A, will appreciate, the demand for that currency increases and supply for country B’s will increase. Same effects as #2.
5. Increases in GDP and people’s income in Country A will lead to greater demand of goods in Country B, leading to similar effects as #2.
6. Political Instability decreases demand for country A’s currency. Similar effects as #2.

Question 7

Currency Market Problems?

Question 8

Pros and cons of strong currency

Answer 8

Pros: Can import cheap goods from abroad, Can encourage foreign investment, Easier for tourists

Cons: Expensive exports, Expensive goods at home

Question 9

Pros and cons of weak currency

Answer 9

Pros: Cheap, competitive exports, makes foreign travel more expensive for local citizens

Cons: Expensive imports

Question 10

Economic prosperity and exchange rate relationship

Answer 10

Countries with stable and growing economies will have higher exchange rates whereas countries with unstable or declining economies will have lower exchange rates.

Question 11

Expansionary fiscal policy impact on currency exchange rate for a given country. Problems?

Answer 11

Depreciation because more disposable income and higher prices as a result means more demand for imported goods (Contractionary policy has the opposite effect). (Changing spending or taxes)

Greater borrowing lifts interest rates throughout the economy (leading to appreciation as investors are attracted to domestic interest-bearing securities)

Question 12

Monetary policy impact on currency exchange rate for a given country. Problems?

Answer 12

Depreciation because more disposable income and higher prices as a result means more demand for imported goods (Expansionary monetary policy)

Expansionary monetary policy can also cause depreciation by lowering interest rates. Contractionary monetary policy will cause appreciation. Interest rates that are higher attract investors.

Question 13

What causes trade surpluses?

Answer 13

One is if a country produces a good or service that is in high demand by other countries but which cannot be produced domestically in those other countries. Ex: Saudi Arabia and oil, Taiwan and semiconductors

Another situation that can lead to a trade surplus is if a country has a competitive advantage in the production of a good or service. This could be due to a variety of factors, including lower labor costs, access to raw materials, or technological advantages. Ex: China has such an advantage in production of many goods and services allowing it to produce more cheaply that other countries, making their exports attractive.

Question 14

Effects of trade surpluses?

Answer 14

Appreciation of currency and inflation due to increased demand for given country’s goods

Question 15

What causes trade deficits?

Answer 15

Drops in productivity

Currency appreciation

Budget deficits

Question 16

Effects of trade deficits?

Answer 16

Positive: Can be a sign of economic growth as it may indicate people have more income to buy more goods and services, including foreign goods and services. People can consume beyond their country’s PPF.

Negative: outsourcing of jobs, Currency depreciation

Question 17

Balance of payments definition and formula. Problems? (Review)

Answer 17

A record of money going in and out of a country

Current account+capital account financial account

Always equals 0.

CA=-CFA always.

Question 18

Current account (Review)

Answer 18

an important indicator about an economy’s health and is defined as the sum of the balance of trade, which is goods and services exported minus imports, net income from abroad and net current transfers.

Money coming in (Credit)
Money going out (Debit)

Remittances
Factor income (the net of payments received and payments made on investments overseas like dividends on stocks)
Foreign aid or donations
Imports and exports

Question 19

Infant industry argument

Answer 19

Protect new industries in a country from competition through trade barriers.

They cannot compete with larger, more established foreign competitors that can produce goods at a lower cost.

Ex: Protecting a developing auto industry from foreign competitors through tariffs etc..

Question 20

Tariffs impact on economy

Answer 20

Decrease in economic surplus (Boost in producer surplus for domestic producers, decline in consumer surplus for domestic consumers)

Prices goes up in market, leading to more expensive goods and lower quantity demanded

https://www.youtube.com/watch?v=3pSysspeCxY

Question 21

Quotas impact on economy

Answer 21

The quotas concept is usually in line with the law of demand and supply, so the prices heighten and the supply declines, just like in tariffs.

The economic impact of a quota is the downswing in consumer surplus in the import market and an upswing of the same in the export market. Generally, import quotas hedge domestic interests by enabling domestic producers and suppliers to thrive domestically without excessive and stiff competition from imports.

Question 22

Net capital outflow

Answer 22

On net, how much money is going out due to investments from a country in foreign assets,

Foreign assets purchased by domestic residents - the purchase of domestic assets by foreigners

Assets can be stocks in domestic companies purchased by foreigners and domestic residents purchasing stocks in foreign companies etc..

Question 23

Factors affecting country’s balance of trade

Answer 23

Costs of producing goods
Availability of inputs necessary to produce goods
International Trade Agreements
Exchange rates
Trade barriers
Prices of domestic goods