Econ 420 FV midterm - 1. a) Amortization Amortization is...

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1. a) Amortization – Amortization is partial repayment of loan. If a country borrows money, it has to pay back the principle to the lender in each year. This payment is called amortization which will be recorded as debit from this country’s capital account. b) Fixed Exchange Rate – The government or Central Bank could control the exchange rate as a specific rate to give exchange rate stability. This is an advantage that there would not have exchange risk, but there is a disadvantage as it cannot respond flexibly when the world is changing. c) Marshall-Lerner Condition - The Marshall Lerner condition states that if the sum of elasticity of demand for exports and imports between two countries is greater than 1, devaluation improves the trade balance of deficit countries. If the sum of elasticity of demand equals 1, then there will be no change. If the sum of elasticity of demand is less than 1, devaluation would have a negative effect on the trade balance of deficit countries. d) Purchasing power parity - Purchasing power parity states that the exchange rate is determined by the price ratio of two countries. (e.g. E$/e=Pus/Peu). PPP relies on the law of one price which means that same goods in different countries should have the same value. However, PPP may not accurately determine exchange rates because it does not take into account transactions costs, non-tradeable goods/services, difference in quality of good/services, trade barriers, and ignores capital movements. e) When there is external disequilibrium, government can implement fiscal policy and/or monetary policy to bring back the external equilibrium. Suppose, a country has internal equilibrium, but BOP deficit. Adjustment to BOP equilibrium along the bb curve can be done through the adjustment in IS curve or LM curve from fiscal policy or monetary policy. f) If there is appreciation, exports will decrease and imports will increase. In this case, the price of import goods will be lower than before. Thus, the price of domestic products will go down and gain international competitiveness. Therefore, exports will increase and imports will decrease. This result will cancel off the benefit of appreciation. g) Autonomous capital movements are the movements of capital for profit motivation and these
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This note was uploaded on 06/13/2011 for the course ECON 420 taught by Professor Staff during the Fall '08 term at University of Illinois, Urbana Champaign.

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Econ 420 FV midterm - 1. a) Amortization Amortization is...

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