lecture notes march 31

# lecture notes march 31 - M Lecture Notes A Exchange Rate...

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March 31, 2011 Lecture Notes A.)Exchange Rate Terminology a. Flexible e, e increase, value of peso decreases, depreciation b. Flexible e, e decreases, value of peso increases, appreciation B.)Trade-Based Model a. Part of Fundamental Accounting equations i. Foreign savings = trade deficit b. Rewrite this relationship using symbols i. Sf (foreign savings) = z (imports) – e (exports) = (Z-E) c. Use Mexico and home country and US as foreign country d. SF is foreign savings i. Savings supplied by US residents who buy Mexican assets ii. Sf is a demand for pesos (supply of dollars) by US 1. Demand is invariant with respect to value of peso 2. Gives us the perfectly inelastic demand C.)Exchange Rates and Trade Flows a. Relationship between e and the trade deficit b. Consider the case of Mexico’s imports and exports i. World prices (pw) are typically in US dollar terms ii. Mexican prices (PM) are in peso terms 1. Relationship between the peso and world prices of Mexico’s import (z) goods can be expressed as P (Mz) = E x P (wz) 2. P (wz) is in dollar terms, multiplying it be e gives us P (mz) in peso terms, remember that e = local currency/foreign currency 3. P (wz) is in dollar terms, multiply it by “e” gives us P (mz) in peso terms, remember that e= (local currency/foreign currency) c. Relationship between the peso and dollar prices of Mexico’s exported (e) goods can be expressed as i. P (me) = e x P (we) or P (we)= P (me)/e 1. P (we) is in dollar terms, multiplying it by E gives us P (me) in peso terms, remember that e=local currency/foreign currency

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2. E increases, exports increases (exchange rate increase make exports go up) 3. E increases (formula 2), exports increase 4. E decreases, exports decrease, a.
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