Economics-Chapter29 - Economics Chapter 29 The economic...

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Economics Chapter 29: The economic benefits of trade between countries in goods, services and assets are similar to the benefits of trade within a country. In both cases, trade in goods and services permits greater specialization and efficiency, whereas trade in assets allows financial investors to earn higher returns while providing funds for worthwhile capital projects. Trade = Exports + Imports Nominal exchange rate: the rate, or price, at which two currencies can be traded for each other → the relative price of currencies in two countries; e = foreign currency per EUR → 1/e = EUR per unit of foreign currency Exchange rate can be expressed either as the amount of foreign currency needed to purchase 1EUR or as the number of euros needed to purchase one unit of the foreign currency. Appreciation: an increase in the value of a currency relative to other currencies depreciation: a decrease in the value of a currency relative to other currencies flexible (floating) exchange rate: an exchange rate whose value is not officially fixed but varies according to the supply of and demand for the currency in the foreign exchange market foreign exchange market: the market on which currencies of various nations are traded for one another fixed exchange rate: an exchange rate whose value is set by official government policy real exchange rate: the price of the average domestic good or service relative to the price of the average foreign good or service, when prices are expressed in terms of a common currency → relative price of goods in two countries; also called terms of trade Formally: If price at home P, price abroad P f , and nominal exchange rate e, real exchange rate is = e x P/P f The real exchange rate has important implications for a country's competitiveness. Other things being equal, we would net exports to be lower when the real exchange rate is relatively high but to increase as the real exchange rate falls.
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