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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  Japan, it has  to  pay fo r the m   in Japane s e  ye n.  Whe n a dis tributo r in G e rm any buys  c o pie s   o f Windo ws  Vis ta, it m us t pay fo r the m  in do llars . This  c re ate s  a de m and fo r c urre nc y
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2 A. The  Fo re ig n Exc hang e  Marke t The   fo re ig n e xc hang e  m arke t  is  the  m arke t in whic h the  c urre nc y o f  o ne  c o untry is  e xc hang e d fo r the  c urre nc y o f ano the r. It is  m ade  up o f tho us ands  o f pe o ple  – im po rte rs  and e xpo rte rs ,  banks , trave le rs  and fo re ig n e xc hang e  bro ke rs .  O pe n alm o s t 24  ho urs  be c aus e  o f tim e  diffe re nc e s . B.  Exc hang e  Rate s The   e xc hang e  rate   is  the  pric e  at whic h o ne  c urre nc y e xc hang e s  fo r  ano 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 ans   de pre c iatio n o f the  $. The  $ is  no t  de pre c iating  ve rs us   Me xic an Pe s o ,  Japane s e  Ye n, o r  C hine s e  Yuan.
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4 C. Nominal and Real Exchange Rates The   no m inal e xc hang e  rate   is  the  value  o f the  U.S . do llar e xpre s s e d in units  o f  fo re ig n c urre nc y pe r U.S . do llar. E = 0.69 Euro s /$1 The   re al e xc hang e  rate   is  the  re lative  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 hang e  rate  is  jus t a pric e  o f o ne  c urre nc y in te rm s  o f ano the r.   Like  all pric e s , it is  de te rm ine d in a m arke t. A. De m and in the  Fo re ig n Exc hang e  Marke t Pe o ple  de m and US  do llars  in o rde r to  buy US  pro duc e d g o o ds   and s e rvic e s  – e xpo rts .  Als o  pe o ple  ne e d US  do llars  to  buy  as s e ts  s uc h as  bo nds , s to c ks , bus ine s s e s , re al e s tate , e tc .
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