Macro (EC102)_ Net Exports 1
Macro (EC102)_ Net Exports 1 EC102
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This 3 page Study Guide was uploaded by Linda Perks on Monday February 29, 2016. The Study Guide belongs to EC102 at Boston University taught by Watson in Spring 2016. Since its upload, it has received 50 views. For similar materials see Macroeconomics in Economcs at Boston University.
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Date Created: 02/29/16
Zara Mahmood Oct 22, 2013 EC102 Lecture 10: Net Exports (NX) The Fundamental Macro Equation GDP = Aggregate Expenditure (AE) o Y = C + I + G + NX Exchange Rates Nominal Exchange Rate – Price of one currency in terms of another currency o Number of units of foreign currency per unit of domestic currency What Causes E to Fluctuate? 2012 volume of international currency transactions was o $794 Billion per day What accounts for the other 95%-98% o Speculation o World trade in assets Equilibrium in the Market for Foreign Exchange Currency appreciation – An increase in the market value of one currency relative to another currency Currency Depreciation– A decrease in the market value of one currency relative to another currency Shifts in Demand and Supply Affect the Exchange Rate Shifts in the demand for foreign exchange Speculators – Currency traders who buy and sell foreign exchange in an attempt to profit from changes in exchange rates Exchange Rates Nominal exchange rate – price of one currency in terms of another currency number of units of foreign currency per unit of domestic currency Price x 1$ / exchange rate Real Exchange Rate – the price of goods in one country in terms of the price of goods in some other country. Assume a hotel room in Mumbai costs R9,150 per night the current R/$ exchange rate is R61=1 How much does the room cost in dollars R9,150/Room/R61/1$= R9150/RoomX1$/R61=$150/Room What Causes E to Fluctuate An important determinant of E is r, the real interest rate. Zara Mahmood Oct 22, 2013 EC102 r(US) increase (relative to the r in the rest of the world) o then the Demand for $-dominated assets (bonds, stocks) increases Demand for $ goes up Price of a US dollar goes up nominal exchange rate goes up, E= nominal exchange rate Real Exchange Rate Price of watch in US: $100 Price of identical watch in Switzerland SF300 Nominal exchange rate = SF1.5 = $1 o watch in U.S. costs SF150 Real exchange Rate – E = P(Domestic)X E/P(foreign) Swiss watch is worth or will buy 2 American watches, the real exchange rate is 1/2 Swiss watch = 1 American watch. another way, an American watch is half as expensive as a Swiss watch. E=nominal exchange rate. e will change if: E changes Example: E goes from SF 1.5= 1$ to SF3 =1$ 1 swiss watch now = 1 American watch. Real exchange rate Sample problem Euro-zone price level = 288 o U.S Price level = 240 Nominal echange rate : .71 euros= $1 What is the real exchange rate between the Euro-zone and the U.S. 240X.71/288=.59 Purchasing Power Parity (PPP) E should be such that e=1 e= P(Dom) X E/P(FOR) e=1 E=P(For)/P(Dom) In our example, P(dom)= 100$, P(for) = SF300 so if e=1, it must be that E = SF300/$100= SF3/1$ Zara Mahmood Oct 22, 2013 EC102 PPP and the Big Mac index if E is at the PPP level, e=1 if e>1m then E is too high, i.e., the foreign currency is undervalued relative to the domestic currency. Recently, a Big Mac cost: 15.4 yuan in Beijing $4.20 in U.S. if PPP held and e=1, then E would have to be: P(for)/P(dom)= 15.4/4.20= 3.67 instead E= 6.32 yuan to the dollar so yuan is 41.9% of the dollor. = $4.20 X 6.32/15.4 =1.83 Recently, A Big Mac cost: SF 6.5 in Switzerland $4.20 in U.S. if PPP held and e=1, then E would have to be P(for)/P(dom)= 6.5/4.20= 1.55 instead E= SF ,96 to the dollar so the swiss frank is 41.9% overvalued. Limitations of PPP theory Two reasons why echange rates do not always adjust to equalize prices across countries: o Many goods cannot easily be traded o Examples: haircuts, going to the movies o Price differences on such goods cannot be arbitraged away o Foreign, domestic goods not perfect substitutes. Nonetheless, PPP works well in many cases, especially as an explanation of laog-run trends PPP and its implications PPP implies that the nominal exchange rate between two countries should equal the ration of price levels If the two countries have different inflation rates, then E ail change over time If inflation is higher in Mexico than in the US, then P(for) rises faster than P(dom) so E rises- the dollar appreciates against eh peso. If inflation is higher in the US than in Japan, then P(dom) rises faster than P(for), so E falls-
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