Download Trade and the Exchange Rate

 We
have several different exchange rates, one for
each currency.
 It
measures how much we would get in terms of
the other currency per $1 NZ.
http://www.x-rates.com/calculator.html
 If
an exchange rate increases, our $NZ is
appreciating.

This means that we are now getting more of the other
currency per $1 NZ.
 If
an exchange rate is decreasing, our $NZ is
depreciating.

This means that we are now getting less of the other
currency per $1 NZ.
 When
we buy goods or services from other countries
we must pay them in their currency. Therefore we
must sell (SUPPLY) our dollar in return for the other
currency.

Hence why we have exchange rates, we need to know how
much of other countries currency we would get in return for
every $1 NZ.
 This
also works in reverse: when other countries want
to buy our exports they must sell their currency in
return for our $NZ (DEMAND for the $NZ) in order
to pay for the goods.
 This
means that the ‘market’ (demand and supply) for
our NZ dollar determines the exchange rate.
 Things
that will increase the demand for the $NZ:
Exports increase (more demand for our $NZ to pay
for these)
 Foreigners investing in NZ (they must invest in NZ in
our currency) i.e. our interest rate is high.
 Borrowing from abroad (they must lend us the money
in $NZ in order for us to use it)
 Increase in tourists coming to NZ.

 Things
that will increase the supply of the $NZ:
Imports increase (we need to sell more of our $ to
get more of the foreign currency to pay for these)
 NZer’s invest more overseas (we must invest in the
currency that the country uses i.e. Japan-Yen)
 Paying back loans to overseas lenders.
 More NZer’s traveling overseas (we must sell our
$NZ to get the currency to spend in the country we
are traveling overseas).

 The
supply and demand model shows both
appreciation and depreciation.
Market for the $NZ
(depreciation)
Price
($US)
Market for the $NZ
(appreciation)
Price
($US)
s
s
s’
d’
d
Quantity
d
Quantity
 Trade
weighted index is a weighted average
from five different currencies in terms of the
NZ exchange rate.

Australian dollar, UK pound, US dollar, Japanese
yen, and the euro.
 When
the TWI is increasing, on average our
exchange rate is increasing which means our
$NZ is appreciating.
 When
the TWI is decreasing, on average our
exchange rate is decreasing which means our
$NZ is depreciating.
 When
the exchange rate appreciates it becomes
relatively more expensive for foreign countries to
buy our exports, therefore we lose our international
competitiveness.

If the Australian dollar increases from 0.5 to 1.0 a good
that will cost $10 NZ will have cost them:



$5 originally
$10 when the NZ dollar appreciates.
Our goods are now relatively more expensive therefore we lose
our international competitiveness. Australia will demand less of
our goods and more of another countries.
 The
exchange rate effects our NZ exports because we
are a price taker country.

So no matter what happens people pay for our exports in
terms of a price in usually $US.

When the exchange rate rises and the NZ dollar appreciates,
exports stay the same price in terms of the $US.

Example: Exchange rate in $US is 0.5, and it appreciates to 1.0. A
kg of cheese costs US$10.

At the original exchange rate NZ exporters of cheese would
receive $20. At the new exchange rate NZ exporters would
receive $10. NZ exporters are worse off.

When the exchange rate falls and the NZ dollar depreciates,
our exporters are better off because they are receiving more
for their goods.
 When
the $NZ appreciates, imports become
relatively cheaper.

NZ exchange rate in terms of the $US goes from 0.5
to 1.0. (US$1 originally cost us $2 NZ (1÷0.5), to
$1(1÷1.0)). A good that costs US$10 originally cost
us $20, now costs us $10.
 When
the $NZ depreciates, imports become
relatively more expensive.

NZ exchange rate in terms of the $US goes from 1.0
to 0.5. A good that costs US$10 originally costs us
$10, now costs us $20 (1÷0.5=$2).
Market for the $NZ (depreciating)
HAPPY farmers (X), therefore unhappy
importers!
Market for the $NZ
(appreciating)
UNHAPPY farmers (X),
therefore happy importers!
Price ($)
Price ($)
S
S
S’
D’
D
Quantity
(units)
D
Quantity
(units)
measures the purchasing power of a nation’s
exports (in terms of what we receive for exports and what
we pay for our imports).
 This
T
of T = Index of export prices × base yr index
Index of imported prices
value
 When
it becomes more expensive to buy imports our
purchasing power decreases (ToT).
 When
it becomes less expensive to buy imports our
purchasing power increases (ToT).
1.
What does the terms of trade measure?
2.
Explain what a favourable movement in the ToT
means.
3.
Explain what an unfavourable movement in the
ToT means.
1.
Measures the volume of imports that can be
bought by a given volume of exports sold.
2.
More imports can be bought by a given volume
of exports sold than previously.
3.
Less imports can be bought by a given volume
of exports sold than previously.