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Lecture 18 - ECO100 - Introduction to Introduction...

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© Gustavo Indart Slide 1 ECO 100Y ECO 100Y Introduction to Introduction to Economics Economics Lecture 18: Lecture 18: The Exchange Rate and The Exchange Rate and the Balance of Payments the Balance of Payments
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© Gustavo Indart Slide 2 Balance of Payments Balance of Payments The balance of payments shows the record of all transactions of residents of Canada with the rest of the world There are two main accounts in the balance of payments: ¾ Current account Merchandise account Service account ¾ Capital account
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© Gustavo Indart Slide 3 Foreign Exchange Rate Foreign Exchange Rate The foreign exchange rate (or the exchange rate ) is the value of one unit of foreign currency in terms of Canadian dollars (e) ¾ There is, therefore, one exchange rate for each currency in the world The value of the Canadian dollar in terms of a foreign currency is equal to the inverse of the exchange rate (1/e) For example, the exchange rate for the U.S. dollar is approximately 1.22 (that is, one U.S. dollar is exchanged for 1.22 Canadian dollars) Therefore, the value of the Canadian dollar in terms of U.S. dollars is 1/1.22 = 0.80 ¾ That is, one Canadian dollar is exchanged for 1.22 U.S. dollars
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© Gustavo Indart Slide 4 Flexible and Fixed Exchange Flexible and Fixed Exchange Rate Systems Rate Systems There are 2 main systems determining the value of the exchange rate: ¾ Flexible exchange rate system ¾ Fixed exchange rate system Flexible exchange rate system – The value of the exchange rate is determined by market forces, i.e., by the demand and supply of foreign exchange in the foreign exchange market Fixed exchange rate – The value of the exchange rate is set by the Bank of Canada
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© Gustavo Indart Slide 5 Supply of Foreign Currency Supply of Foreign Currency Since foreign currency is exchanged for Canadian dollars, a supply of foreign currency implies a demand for Canadian dollars ¾ That is, those who supply foreign currency are demanding Canadian currency in the exchange market The supply of foreign currency in the exchange market originates from: ¾ Canadian exports of goods and services ¾ Capital inflows (e.g., foreign investment) ¾ Foreign visitors to Canada
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© Gustavo Indart Slide 6 Demand for Foreign Currency Demand for Foreign Currency Since foreign currency is exchanged for Canadian dollars, a demand for foreign currency implies a supply of Canadian dollars ¾ That is, those who demand foreign currency are supplying Canadian currency in the exchange market The demand for foreign currency in the exchange market originates from: ¾ Canadian imports of goods and services ¾ Capital outflows (e.g., Canadian investment abroad) ¾ Canadian visitors to other countries
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© Gustavo Indart Slide 7 Demand and Supply of Foreign
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