FINAL GUIDE

FINAL GUIDE - FinalReview Chapter 18, Openness in Goods and...

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Final Review 00:16 Chapter 18, Openness in Goods and Financial Markets Exports and Imports US doubled imports/exports relative to GDP since 1960’s Tradable Goods – goods that compete with foreign goods in either domestic or foreign markets Distance from markets as well as size affect how much a country imports or exports Choice between Domestic or Foreign Goods Open economy = 2 Decisions o Save or Buy o Buy domestic or foreign? Nominal Exchange Rates Nominal Exchange Rate – o As the price of domestic currency in terms of foreign currency o As the price of foreign currency in terms of domestic currency Denoted as “E” Appreciation (of domestic currency)– increase in the price of the domestic currency in terms of a foreign currency Depreciation (of domestic currency)– decrease in the price of domestic currency in terms of foreign currency. Fixed Exchange Rates – a system in which two or more countries maintain a constant exchange rate between their currencies. o Revaluation - Increase in exchange rate o Devaluation – decrease in exchange rate From nominal to Real Exchange Rates
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ε = EP/P* Price of domestic goods in terms of foreign goods. Real exchange rate is uninformative because it is the index or GDP deflators which is another index. Rather, the change in real exchange rate is informative and shows change amongst exchange rates Increase in real exchange rate = real appreciation o Increase in the relative price of domestic goods in terms of foreign goods Decrease in real exchange rate = real depreciation o Decrease in the relative price of domestic goods in terms of foreign goods Nominal appreciation and a real depreciation possible? Yes o E , has increase. Dollar has gone up in terms of pounds o P/P* has decreased. The price level has increased less in the US than in the UK. Avg. inflation was lower in the US than in the UK o Decrease in P/P* was bigger than the increase in E leading to a decrease in ε From Bilateral to Multilateral Exchange Rates Weigh each country by how much each country trades with the US and how much it competes with the US in other countries. - Multilateral Real U.S. Exchange Rate - Variable constructed through this mechanism ^ Openness in Financial Markets Foreign Exchange – buying or selling foreign currency Daily foreign exchange markets trade approx. $1.9 trillion per day. The Balance of Payments Balance of payments – a country’s transactions with the rest of the world including both trade flows and financial flows. o The Current Account (above the line)
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Records payments to and from the rest of the world. Exports and Imports of Goods and Services Investment income (holding foreign assets) Net Transfers (foreign aid given or received) o Capitol Account (below the line) –How much the country has to borrow to make up for deficit or can lend) Increase in foreign holdings of US assets Increase in US holdings of foreign assets
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FINAL GUIDE - FinalReview Chapter 18, Openness in Goods and...

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