econ122lec6slides

# econ122lec6slides - Econ 122 Lecture 6: Exchange Rates, the...

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Econ 122 Lecture 6: Exchange Rates, the FX Market and Prices Joel M. David UCLA August 23, 2010 Joel M. David (UCLA) August 23, 2010 1 / 24

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Exchange Rates Exchange rate E : the number of units of domestic currency needed to buy one unit of foreign currency, i.e., the price of the foreign currency expressed in terms of the domestic currency. Careful with units: exchange rate will always be expressed as E = E domestic / foreign . Example: the current dollar-euro exchange rate, or the dollar price of the euro is \$1.22, i.e., E \$/ e = 1 . 22. When E rises: depreciation of the domestic currency. The value of the domestic currency has declined since more units of the domestic currency are needed to purchase one unit of the foreign currency. When E falls: appreciation. Joel M. David (UCLA) August 23, 2010 2 / 24
Exchange Rates and Relative Prices Example: You are thinking of purchasing an iPhone, but heard they are cheaper in Japan. The price in America is \$400. When you go online, you &nd the price in Japan is U 30,000, and the dollar-yen exchange rate is E = 0 . 011 . To express these in a common currency, we &nd the dollar price in Japan as P = U 30 , 000 & 0 . 011 \$/ U = \$ 330 so the iPhone is indeed cheaper in Japan. If the dollar appreciates, E falls and Japanese iPhone becomes cheaper. If the dollar depreciates, E rises, and the Japanese iPhone becomes more expensive. These changes will impact the international ±ow of goods. Changes in the exchange rate cause changes in the domestic prices of foreign goods and vice versa: When the domestic currency depreciates, foreign imports become more expensive and and domestic exports become cheaper abroad. Result is less imports and more exports. When the domestic currency appreciates, foreign imports beecome cheaper and domestic exports become more expensive abroad. Result is more imports and less exports. Joel M. David (UCLA) August 23, 2010 3 / 24

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Exchange Rate Regimes Fixed (or pegged) exchange rate regime: the domestic government determines the exchange rate E by intervening in the foreign exchange market. The currency is only allowed to &uctuate in a narrow band, or not at all against some base currency. Floating exchange rate regime: the market determines the exchange rate E . The exchange rate is allowed to &uctuate freely and is subject to constant appreciations and depreciations. There are some intermediates: crawls, bands, etc. Joel M. David (UCLA) August 23, 2010 4 / 24
Exchange Rates - Developed Countries Joel M. David (UCLA) August 23, 2010 5 / 24

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Exchange Rates - Developing Countries Joel M. David (UCLA) August 23, 2010 6 / 24
Exchange Rates Experiences Floating exchange rates &uctuate in developed countries and are even more volatile in developing countries.

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## This note was uploaded on 07/27/2011 for the course ECON 122 taught by Professor Staff during the Summer '08 term at UCLA.

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econ122lec6slides - Econ 122 Lecture 6: Exchange Rates, the...

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