2. 1 Welcome to Econ 414 International Economics Study Guide Week Thirteen

3. 2 Exchange Rates and Their Determination: A Basic Model CHAPTER 13

4. 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?

5. 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

6. 5 What is the rate of depreciation of dollar? %Δ = (1.43-1.53)* 100 /1.43 = -7% Dollar depreciated by 7%

7. 6 Euros per Dollar: What is causing these fluctuations?

8. 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

9. 8 Demand and Supply Forces Affect the Exchange Rate. Foreign Exchange Market 1.Demand Curve Shows the quantity demanded for a currency by residents of another country at different exchange rates. 2.Supply Curve Shows the amount of a currency supplied at a different exchange rates.

10. 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

11. 10 The Demand for euro euros $/€ Demand for Euros $1 $2 $3 € 1 € 2 € 3

12. 11 Shifts: What if US GDP goes up? Euros $/€ Demand for euros D1D1 D2D2 US income goes up  Demand  D1

13. 12 International Economics Week Ten –Class 2 –Wednesday, November 7 –11:10-12:00 –Tyndall

14. 13 Shifts: What if US Prices go down? Euros $/€ Demand for euros D1D1 D2D2 Americans buy fewer European goods  Demand goes down  D 2

15. 14 Shifts: What if interest rates in Europe go up? Euros $/€ Demand for euros D1D1 D2D2 US residents would want to buy more European bonds Demand  D1

16. 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

17. 16 The Supply of Euros Supply of Euros euros $/€ $1 $2 $3 €1€1 €2€2 €3€3

18. 17 Shifts: What if European’s income goes up? Supply of Euros Euros $/€ S1S1 S2S2 Europeans will want to buy more American goods  Supply of euro goes up to S 1

19. 18 Shifts: What if Europeans expect euro to appreciate further in the near future? Supply of Euros Euros $/€ S1S1 S2S2 Europeans will supply less now  Supply of euro goes down to S 2

20. 19 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. Equilibrium in the Foreign Exchange Market

21. 20 Equilibrium Exchange Rate Supply of Euros $/Euro 1.5 2.0 2.5 100200400Euros Demand for Euros 300500

22. 21 What if Europe’s GDP goes up? Supply of Euros $/Euro 1.5 2.0 2.5 100200400Euros Demand for Euros 300500 Supply of euro goes up to S1 S1 Euro depreciates

23. 22 What if US prices go up and EU prices don’t Supply of Euros Demand for Euros $/Euro 1.5 2.0 2.5 100200400Euros300500 3.0 D1 S1 Demand goes up because Americans would want to buy more European goods Supply goes down because Europeans buy fewer American goods Euro appreciates

24. 23 Are fluctuations in the value of a currency good or bad for the economy? No surplus/ shortage –Good

25. 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

26. 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

27. 26 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. Fluctuating exchange rates have led to an industry of forecasters.

28. 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!!!!