TAILIEUCHUNG - 15. Principles of Economics (Brief Edition)_2e (21)

Chapter 21: Exchange Rates,. International Trade, and Capital . Define the nominal exchange rate and use supply and demand. to analyze how the nominal exchange rate is determined in the. short . Distinguish between fixed and flexible exchange rates and. discuss the advantages and disadvantages of each . Define the real exchange rate and show how it is related to the. prices of goods across pairs of . Understand the law of one price and apply the purchasing. power parity theory of exchange rates to long-run equilibrium. exchange rate . Analyze the factors that determine international capital flows. and how these factors affect domestic saving and the. domestic real interest . Use the relationship between domestic saving and the trade. balance to understand how domestic saving, the trade. balance, and net capital inflows are related. McGraw­Hill/Irwin Copyright © 2011 by The McGraw­Hill Companies, Inc. All rights reserved. Nominal Exchange Rates.• The nominal exchange rate is the rate at. which two currencies can be traded for each. other. Consider 3 currencies: $, C$, and £. One dollar buys £ or C$ . The exchange rate between UK pounds and. Canadian dollars can be calculated from this. information. £ = C$ . £ 1 = C$ / . £ 1 = C$ . OR. C$ 1 = £ / . C$ 1 = £ 21­2 Importance of Exchange Rates.• Domestic purchases are made with local. currency. – Purchasing goods abroad requires converting your. local currency to their local currency. • The exchange rate measures the rate of conversion.• Exchange rates are set in the foreign exchange. market, with a small number of exceptions. – Rates are determined by supply and demand. – Affect the value of imported goods and the value of. financial investments made across borders. • Changes in exchange rates can have a significant. effect on most economies. 21­3 Changes in Exchange Rates.• Appreciation is an increase in the value of a currency. relative to other currencies.• Depreciation is a decrease in the value of a currency. relative to other currencies Exchange Rates.• Definition. – e = the number of units of foreign currency that each unit of. domestic currency will buy.• Domestic currency appreciates if e increases.• Domestic currency depreciates if e decreases 21­4 Exchange Rate Strategies.– The foreign exchange market is the market on which. currencies of various nations are traded.• A flexible exchange rate is an exchange rate whose. value is not officially fixed but varies according to the. supply and demand for the currency in the foreign. exchange market.• A fixed exchange rate is an exchange rate set by. official government policy.– Can be set independently or by agreement with a number. of other governments.– Fixed rates can be set relative to the dollar, the euro, or. even gold. 21­5 Flexible Exchange Rate in the. Short Run.• Exchange rates are set by supply and demand. in the foreign exchange market.• Dollars are demanded by foreigners who seek to. purchase . goods or financial assets. – Number of dollars foreigners seek to buy.• Dollars are supplied by . residents who need. foreign currency to buy foreign goods or financial. assets. – Not the same as the money supply set by the Fed. – Number of dollars offered in exchange for other. currencies. 21­6 Monetary Policy and the. Exchange Rate.• Monetary policy affects interest ra

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