ExchangeRate - Ch. 10 The Exchange Rate and the Balance of...

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1 Ch. 10  The Exchange Rate and the Balance of Payments In this section, we will discuss exchange rates, the foreign exchange market, financing  international trade, and exchange rate policy I. Currencies and Exchange Rates Whe n a  de ale r im po rts  a  c ar fro m  Japa n, it ha s  to  pa y fo r the m   in Ja pane s e  ye n.  Whe n a dis tributo r in G e rm a ny b uys  c o pie s   o f Windo ws  Vis ta , it m us t pay fo r the m  in do lla rs . This  c re a te s  a  de m and fo r c urre nc y
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2 A. The  Fo re ig n Exc ha ng e  Ma rke t The   fo re ig n e xc ha ng e  m a rke t  is  the  m a rke t in whic h the  c urre nc y o f  o ne  c o untry is  e xc ha ng e d fo r the  c urre nc y o f a no the r. It is  m a de  up o f tho us a nds  o f pe o ple  – im po rte rs  a nd e xpo rte rs ,  b a nks , tra ve le rs  a nd fo re ig n e xc ha ng e  b ro ke rs .  O pe n a lm o s t 24  ho urs  b e c a us e  o f tim e  diffe re nc e s . B.  Exc ha ng e  Ra te s The   e xc ha ng e  ra te   is  the  pric e  a t whic h o ne  c urre nc y e xc ha ng e s  fo r  a no the r c urre nc y. C urre ntly, $1 is  wo rth o nly 0.69 Euro s ,  $1 is  wo rth o nly 0.51 Britis h  po unds .
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3 No te  ho w it is  de fine d.   De c re as e  m e a ns   de pre c ia tio n o f the  $. The  $ is  no t  de pre c ia ting  ve rs us   Me xic a n Pe s o ,  Ja pa ne s e  Ye n, o r  C hine s e  Yua n.
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4 C. Nominal and Real Exchange Rates The   no m ina l e xc ha ng e  rate   is  the  value  o f the  U.S . do lla r e xpre s s e d in units  o f  fo re ig n c urre nc y pe r U.S . do lla r. E = 0.69 Euro s /$1 The   re a l e xc ha ng e  ra te   is  the  re la tive  pric e  o f fo re ig n-pro duc e d g o o ds  and  s e rvic e s  to  U.S .-pro duc e d g o o ds  and s e rvic e s .  RER = E x (US price level/Foreign price level If nominal enxchange rate changes and US price over Foreign price changes, then RER changes It is a measure of the quantity of the real GDP of other countries that we get for a unit  of U.S. real GDP RER = E x (P/P*)  where E is the nominal exchange rate defined as above, P is the U.S.  price level and P* is the other country’s price level. The real exchange changes if the nominal exchange rate changes but prices don’t.
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5 II. The Foreign Exchange Market An e xc ha ng e  ra te  is  jus t a  pric e  o f o ne  c urre nc y in te rm s  o f a no the r.   Like  a ll pric e s , it is  de te rm ine d in a  m a rke t. A.
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ExchangeRate - Ch. 10 The Exchange Rate and the Balance of...

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