1 © ©1999 South-Western College Publishing PowerPoint Slides prepared by Ken Long Principles of Economics 2nd edition by Fred M Gottheil

2 Chapter 32 Exchange Rates, Balance of Payments, and International Debt 1/13/2016 © ©1999 South-Western College Publishing

3 This chapter discusses principles associated with © ©1999 South-Western College Publishing Balance of PaymentsDevaluationArbitrage Floating and Fixed Exchange Rates Appreciation and Depreciation of Currencies Foreign Exchange MarketsExchange Rates International Debt and Debt Service

4 What determines the demand for a currency on the international market? Foreigners demand a another country’s currency to purchase its goods. © ©1999 South-Western College Publishing

5 What is an Exchange Rate? The price of one country’s currency measured in terms of another country’s currency © ©1999 South-Western College Publishing

6 What determines the exchange rate of a country’s currency? The supply and demand for that currency on the international market © ©1999 South-Western College Publishing

7 What determines the Supply and Demand of a currency? Relative... price levels rates of interest rates of growth © ©1999 South-Western College Publishing

8 What causes the Supply Curve for a country’s currency to shift? Changes in... © ©1999 South-Western College Publishing Income Tastes Interest rates

9 S1 S2 P1 Increase in Supply P2 Q2 Q1 D 9 © ©1999 South-Western College Publishing

10 What causes the Demand Curve for a country’s currency to shift? Changes in... Income Tastes Interest rates © ©1999 South-Western College Publishing

11 S D2 P1 Increase in Demand P2 Q2 Q1 D1 11 © ©1999 South-Western College Publishing

12 What is a Floating Exchange Rate? An exchange rate determined strictly by the demands for and supplies of a country’s currency © ©1999 South-Western College Publishing

13 What is meant by a currency appreciation? A rise in the price of a nation’s currency relative to foreign currencies © ©1999 South-Western College Publishing

14 What is meant by a currency depreciation? A fall in the price of a nation’s currency relative to foreign currencies © ©1999 South-Western College Publishing

15 What creates mutually consistent Exchange Rates? Arbitrage © ©1999 South-Western College Publishing

16 What is Arbitrage? The practice of buying a foreign currency in one market at a low price and selling it in another at a higher price © ©1999 South-Western College Publishing

17 What is a problem with Floating Exchange Rates? The value of a currency may change from the time a good is ordered to when it is delivered © ©1999 South-Western College Publishing

18 How do we minimize this problem? By government intervening in the foreign exchange market, by buying and selling its own currency. © ©1999 South-Western College Publishing

19 What is a Foreign Exchange Reserve? The stock of foreign currencies a government holds © ©1999 South-Western College Publishing

20 How can a county lower the value of its currency on the foreign exchange market? It can sell its currency for foreign currencies, thus increasing the supply © ©1999 South-Western College Publishing

21 For information on Exchange Rates: © ©1999 South-Western College Publishing

22 What is the IMF? An international organization formed to make loans of foreign currencies to countries facing balance of payments problems © ©1999 South-Western College Publishing

23 What is a country’s Balance of Payments? An itemized account of its foreign economic transactions © ©1999 South-Western College Publishing

24 What does it mean to have a Favorable Balance of Trade? Exports > Imports so that more money enters a country than leaves © ©1999 South-Western College Publishing

25 What does it mean to have a deficit on current account? Imports of goods and services are greater than exports of goods and services © ©1999 South-Western College Publishing

26 What is the difference between a Balance of Payments and a Balance of Trade? The balance of payments measures the flow of all money, whereas the balance of trade considers only imports and exports © ©1999 South-Western College Publishing

27 What items in the U.S. balance of payments represent $ outflows? Imports of goods and services Income payments on foreign investments in the U.S. Unilateral transfers abroad Buying foreign assets © ©1999 South-Western College Publishing

28 What is the Balance on Capital Account? A category that itemizes changes in the foreign asset holdings of a nation and that nation’s asset holdings abroad © ©1999 South-Western College Publishing

29 What can stimulate $ inflows into the U.S. balance of payments? High rates of U.S. economic growth Relatively high U.S. interest rates U.S. government borrowing from abroad Increases in U.S. worker’s productivity Devaluation of the U.S. exchange rate © ©1999 South-Western College Publishing

30 Is international debt a major problem for many LDCs? Yes © ©1999 South-Western College Publishing

31 What is a country’s International Debt? The total amount of outstanding IOU’s a nation is obligated to repay other nations and international organizations © ©1999 South-Western College Publishing

32 What is a country’s Debt Service? Interest payments on international debt as a percentage of a nation’s merchandise exports © ©1999 South-Western College Publishing

33 What will eventually undermine a chronic surplus on current account? © ©1999 South-Western College Publishing

34 The country’s exchange rate will appreciate making its exports less attractive and its imports more attractive. © ©1999 South-Western College Publishing

35 What will eventually undermine a chronic deficit on current account? © ©1999 South-Western College Publishing

36 © ©1999 South-Western College Publishing The country’s exchange rate will depreciate making its exports more attractive and its imports less attractive

37 D S P3 Q3 P1 Surplus P2 Deficit 37 © ©1999 South-Western College Publishing

38 38 © ©1999 South-Western College Publishing u/usftu.html

39 What determines the demand for a currency internationally?What determines the demand for a currency internationally? What is a country’s Exchange Rate? What determines the exchange rates of different currencies?What determines the exchange rates of different currencies? What determines the Supply and Demand of a currency?What determines the Supply and Demand of a currency? What is Appreciation?

40 What is Depreciation? What is Balance of Payments? What does it mean to have a Favorable Balance of Payments?What does it mean to have a Favorable Balance of Payments? What does it mean to have a Payments Deficit?What does it mean to have a Payments Deficit? In the long run, how will a Payments Surplus be corrected?In the long run, how will a Payments Surplus be corrected? In the long run, how will a Payments Deficit be corrected?In the long run, how will a Payments Deficit be corrected?

41 ENDEND © ©1999 South-Western College Publishing