1. WARNING!!!!!!!!!!!!!!!!!!!!!!!!! THE MOST IMPORTANT FACTOR IN DETERMINING FOREIGN EXCHANGE IS INTO WHICH NATION IS THE MONEY FLOWING. The currency of that nation will APPRECIATE and the other nation’s currency will DEPRECIATE.

2. Appreciation and Depreciation
Appreciation of a currency occurs when the exchange rate of that currency increases (e↑)
Depreciation of a currency occurs when the exchange rate of that currency decreases (e↓)
Ex. If German tourists flock to America to go shopping, then the supply of Euros will increase and the demand for Dollars will increase. This will cause the Euro to depreciate and the dollar to appreciate.

3. Exchange Rate Determinants
1) Consumer Tastes
Ex. a preference for Japanese goods creates an increase in the supply of dollars
in the currency exchange market which leads to depreciation of the Dollar and
an appreciation of Yen.
2) Relative Income and economic growth rates between nations
Ex. If Mexico’s economy is strong and the U.S. economy is in recession, then Mexicans will buy more American goods, increasing the demand for the Dollar, causing the Dollar to appreciate and the Peso to depreciate (wealthier nations
and those with higher economic growth rates import more products).
3) Relative Price Level Between Nations
Ex. If the price level is higher in Canada than in the United States, then American
goods are relatively cheaper than Canadian goods, thus Canadians will import more American goods causing the U.S. Dollar to appreciate and the Canadian Dollar to depreciate. (money flows to the nation with the lower price levels.)

4. Exchange Rate Determinants (continued)
4) Relative Interest Rates on Financial Investments Between Nations
If interest rates on bonds in the U.S. go up versus those in Europe, then the demand for the dollar will increase and it will appreciate. The supply of the Euro will increase as Europeans exchange their currency for dollars. Thus the Euro will depreciate. (money flows to the nation with the higher interest rates.)
5) Speculation
Ex. If U.S. investors expect that Swiss interest rates will climb in the future, then
Americans will demand Swiss Francs in order to earn the higher rates of return
in Switzerland. This will cause the Dollar to depreciate and the Swiss Franc to
appreciate. (Here, investors will buy Swiss government securities now and sell them in the future when the interest rates actually go up and more people buy those investments, causing the price to go up. Hence, buy low and sell high Basically the same process as stock sales).

5. Exchange Rate Determinants (continued)
Expected rates of return on other investments on stocks, real estate, etc.If expected rates of return on these investments in the U.S. go up versus
those in Europe, then the demand for the dollar will increase and it will
appreciate. The supply of the Euro will increase as Europeans exchange
their currency for dollars. Thus the Euro will depreciate. (money flows to
the nation with the higher expected rate of return.)

6. 2. Depreciation of a Currency: If a currency depreciates, its products become less expensive to other nations, but with depreciation its currency has less buying power. Therefore, exports increase, but imports decrease. This increases Xn (Exports minus Imports). Since Xn is part of AD or GDPr (C + I + G + Xn), then AD/GDPr increases slightly overall.

7. The money flowing into and out of a nation.
Balance of Payments

8. What is Exports minus Imports in terms of Balance of Payments?
Net Exports or Balance of Trade

9. When imports are greater than exports, there is a _________.
trade deficit

10. When exports are greater than imports, there is a _________.
trade surplus

11. Money flowing into a nation
Credit

12. Money out of a nation
Debit

13. The Fed buying or selling foreign currency.
Official Reserves Account

14. Xn, Net Foreign Income, and Net Transfers.
Current Account

15. The purchase of real and financial assets.
Financial Account

16. Tax on imports
Tariff

17. Limit on imports.
Quota

18. Cutting off trade with a nation.
Embargo

19. Who is happy when a tariff is imposed on imports. Why?
The domestic producer and its government. The domestic producer gains more sales and profits. The government gains tax revenue and political support from the domestic producers and their suppliers.

20. Who is sad when a tariff is imposed on imports. Why?
The foreign producer and the consumer. The foreign producer loses sales and profits. The consumer pays higher prices, has less selection, and quality may go down.

21. Why would a nation place an embargo on another country?
1. Punish for bad behavior.
2. Punish for unfair trade practices.
3. Protect “infant” and “mature” industries from
competition.