UNIT 7

UNIT 7

4/3/16

• Foreign Exchange (FOREX)

-The buying and selling of currency

-any transaction that occurs in the balance of payments

• Change in Exchange Rates
• Exchange rates (e) are function of the supply and demand of currency

-an inc in supply of currency will decrease the exchange rate of a currency

-a decrease in supply of a currency will inc the exchange rate of a currency

-an inc in demand will inc exchange rate

-a dec in demand for cur will dec the exch rate of curr

• Appreciation- of a curr occurs when the exchange rate of that currency increase (e^)
• Depreciation- of a curr occurs when the exchange rate of that currency decreases (ev)
• Exchange rate determinants:

-consumer tastes

-Relative income

-relative price level

-Speculation

• Exports and Imports

-the exchange rate is a determinant of both exports and imports

-appreciation

4/5/16

Floating vs flexible

• It is based on the supply and demand if that currency vs. other currency
• It is very sensitive to business cycles and it provides options for investments.
• Fixed rates- it is based on a country’s willingness to distribute other currencies and control it’s amounts

4/26/16

·      Balance of payments- a measure of money that inflows and outflows between the US and the Rest of the world (ROW)

-inflows are referred to as CREDITS

-outflows are referred to as DEBITS

·      The balance of payments is divided into 3 parts:

-Current account

-Capital/ Financial account

-Official Reserves account

·      Double entry bookkeeping

·      Current Account:

Balance of trade of net exports

- EX- IMP

-exports create a credit to the balance of payments

-import create a debit

Net Foreign income

-Income earned by US owned foreign assets- income paid to foreign held US assets

Net transfers (tend to be unilateral)

-Foreign Aidà a debit to the current account

-Ex. Mexicans working

·      Capital/ Financial Account:

-the balance of capital ownership

-includes the purchase of both real and financial assets

-direct investment in the US is a credit to the capital account

Ex. Toyota factory in San Antonio

-Direct investment by US firms/ individuals in a foreign country are debits to the capital account

Ex. Intel Factory in San Jose, Costa Rica

-Purchase of foreign financial assets represents a debit to the capital account

Ex. Warren Buffet buys stock in Petrochina

-Purchase of domestic financial assets by foreigners represents a credit to the capital account

Ex. The UAE sovereign wealth fund purchases a large stake in the NASDAQ

·      Relationship between current and capital account

-The current account and the capital account should zero each other out.

-That is… is the Cur Acc has a negative balance (deficit), then the Capital Account should then have a positive balance (surplus)

·      Official Reserves

-the foreign currency holdings of the US federal reserve system

-When there is a balance if payments surplus the Fed accumulates foreign currency and debits the balance if payments

- When there is a balance if payments deficit the Fed depletes foreign currency and credits the balance if payments

-the official reserve zero out the balance of payments

·      Active v. Passive Official Reserves

-The US is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.

5/10/16

Absolute advantage:

• Individual- exists when a person can produce more of a certain good/service than someone else in the same amount of time (or can produce a good using the least amount of resources)
• National- exists when a country can produce more good/service than another country can in the same time period.

Comparative advantage:

• A person or a nation has a comparative advantage in the production of a product when it can produce a the product at a lower domestic opportunity cost than can a trading partner.
• Output: mph, cars produced per hour
• Input:hours to do a job, # of acres to feed a horse, # of gallons of paint to paint a house

Specialization and Trade

• Gains from trade are based on comparative advantage, not absolute advantage