Exchange Rates CH10

Question 1

What is the Exchange Rate?

Answer 1

Price at which one currency exchanges for another. e.g. NZ exchange rate: price of NZ$ measured in foreign currency. NZ $1.00 = US$0.45

Question 2

What is a Freely Floating Exchange Rate? What is a Managed Exchange Rate?

Answer 2

Freely Floating Exchange Rate:
- No govt intervention.
- Rate free to settle at equilibrium.
Managed Exchange Rate:
- Intervention aimed at influencing direction, size or speed of exchange rate movements.

Question 3

Effect of increase in NZ interest rates?

Answer 3

• Demand for NZ$ rises.
• Supply of NZ$ falls.
• Equilibrium price of NZ$ rises (NZD appreciates).

Question 4

Impact of Growth on Trade?

Answer 4

Faster Domestic Growth:
- Stimulates imports.
Supply of NZ$ increases.
Faster Overseas Growth:
- Stimulates exports.
- Demand for NZ$ increases.

Question 5

Impact of Inflation on Trade?

Answer 5

Supply for NZD increases, as Imports increase (NZ G/S too expensive for domestic buyers).
Demand for NZD decreases, as Exports fall. (NZ G/S too expensive for overseas).

Question 6

Effect of Trade Shocks on Trade?

Answer 6

Rise in Import Prices:
Supply of NZD rises as need more NZD to purchase same amount of imports. Depreciation occurs.
Collapse of Export Prices:
Need less NZD to purchase same amount of exports. Therefore, demand for NZD falls. Depreciation.

Question 7

Define Nominal Exchange Rate

Answer 7

Rate at which a person can trade the currency of one country for the currency of another.

Question 8

Define Real Exchange Rate

Answer 8

• Measure of international competitiveness.
• Units of a foreign item per unit of domestic item.
  Formula:
  Real Exchange rate = (nominal exchange rate x domestic price) / foreign price

real exchange rate = nominal exchange rate x (p of domestic goods in domestic currency / p of foreign goods in foreign currency).

Question 9

Effect of Real Exchange Rate on Trade

Answer 9

Depreciation:
NZ goods relatively cheaper to foreign goods. Encourages foreigners to buy more NZ goods.
Depreciation of NZD means appreciation of foreign currency (real).
Discourages NZ’ers to buy foreign goods.
NZ X rise NZ M fall, NX rise.

Question 10

Purchasing Power Parity?

Answer 10

A good must sell for the same amount in all places.

- Taking advantage of differences in prices in different markets is called arbitrage.