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CHAPTER THIRTY-EIGHT EXCHANGE RATES, THE BALANCE OF POWER, AND TRADE DEFICITS INSTRUCTIONAL OBJECTIVES After completing this chapter, students should be able to: 1. Explain how U.S. exports create a demand for dollars and a supply of foreign exchange; and how U.S. imports create a demand for foreign exchange and a supply of dollars. 2. Explain and identify the various components of the balance of payments. 3. Identify trade and balance of payments deficits or surpluses when given appropriate data. 4. Explain how a nation finances a “deficit” and what it does with a “surplus.” 5. Explain how exchange rates are determined in a flexible system. 6. Explain how flexible exchange rates eliminate balance of payments disequilibria. 7. List five determinants of exchange rates. 8. List three disadvantages of flexible exchange rates. 9. List three ways a nation could control exchange rates under a fixed-rate system. 10. Describe a system based on the gold standard, the Bretton Woods system, and a managed float exchange rate system. 11. Identify the pros and cons of each of the above three systems. 12. Explain the so-called crisis in foreign trade and identify three of its causes. 13. Describe two effects of a trade deficit. 14. Define and identify terms and concepts listed at the end of the chapter. LECTURE NOTES I. Financing International Trade A. Foreign exchange markets enable international transactions to take place by providing markets for the exchange of national currencies. B. An American export transaction is illustrated in Figure 38-1. 1. U.S. firm is selling $30,000 worth of computers to British firm. 2. The exchange rate is $2 = 1 Br. pound, so the British firm must pay 15,000 pounds. 3. The British firm will draw a check on its deposit at a London bank for 15,000 pounds, and will send it to the U.S. exporter. 4. The exporter sells the British check to an American bank for $30,000 in exchange for the British check, and the exporter’s account is credited. 5. The American bank will deposit the 15,000 pounds in a correspondent London bank for future sale. 488
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Exchange Rates, the Balance of Power, and Trade Deficits 6. Note the major points here. a. Exports create a demand for dollars and a supply of foreign money, in this case British pounds. b. The financing of an American export reduces the supply of money (demand deposits) in Britain and increases it in the U.S. C. An American import transaction is illustrated in Figure 38-2. This example illustrates how a British exporter is paid in pounds while the importer pays dollars. 1. A U.S. firm is buying 15,000 pounds worth of compact disks from Britain. 2. The exchange rate remains at $2 = 1 Br. pound, so the American purchaser must exchange its $30,000 for 15,000 Br. pounds at an American bank—perhaps the same one as in the export example. 3.
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This note was uploaded on 02/09/2009 for the course ECON 004 taught by Professor Mateer during the Fall '08 term at Northwestern.

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