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Chapter 34 – Open-Economy Macroeconomics – 34-2 The Role of the Exchange Rate What are the three conclusions laid out in the first 3 P’s. 1 ___________________________________________________________________________ 2 ___________________________________________________________________________ 3 ___________________________________________________________________________ Understanding Exchange Rates When an American company (ie, Best Buy) buys products from Japan (ie, Play Stations), the American company must pay the Japanese company in what currency? ____________________ In conducting this transaction, the American company ________________ Japanese Yen in the currency market and __________________ U.S.$. in that market. This currency _________________ would result in the ____________________ of the JY and the ________________________ of the U.S.$. Movements in exchange rates affect the relative _____________ of goods, services and assets. The Equilibrium Exchange Rate In the currency market, the country that is importing is _________________ their own currency and _________________ another country’s currency. A country that is buying bonds ________________ their own currency and _______________ another country’s currency. When a country’s currency appreciates, their imports _________ and their exports fall. Now note that this next graph gets confusing. Take it one step at a time. Draw a Foreign Exchange Market graph in which $1 = JY 107.94. Include all labels. On this graph, show and label the effects of an increase in demand for U.S.$ by the Japanese to purchase U.S. bonds. What is the effect of this shift on the value of JY in relation to U.S.$? ___________________________________ What will be the effect of this change in currency valuation on the current account? ________________________________________ Now stop! Inflation and Real Exchange Rates What is the real exchange rate? How is it calculated? _____________________________________________________________________________ _____________________________________________________________________________ Why is the real exchange rate so much more valuable as data than the nominal exchange rate? _____________________________________________________________________________ _____________________________________________________________________________ Purchasing Power Parity What does this economic term mean and why is it useful? _____________________________________________________________________________ _____________________________________________________________________________ Why are price levels generally lower in developing countries than in developed countries? _____________________________________________________________________________ How does the Big Mac index show the value of PPP as a predictor of currency movements? _____________________________________________________________________________ _____________________________________________________________________________ How did the U.S. benefit from a week dollar starting around 2006? How did it help stabilize the economy? _________________________________________________________________ _____________________________________________________________________________ CYU 34-2 1. a. ________________________________________________________________ b. ___________________________________________________________________________ c. ___________________________________________________________________________ 2. a. _________________________________________________________________________ b. ___________________________________________________________________________ (p. 939) 6. Q1. _____________________________ Q2. ________________________________ 8. a. b. c. d. 9. a. b. 10. a.__________________b.___________________c._________________d.______________ Chapter 34 – Open-Economy Macroeconomics – 34-2 The Role of the Exchange Rate What are the three conclusions laid out in the first 3 P’s. 1 ___________________________________________________________________________ 2 ___________________________________________________________________________ 3 ___________________________________________________________________________ Understanding Exchange Rates When an American company (ie, Best Buy) buys products from Japan (ie, Play Stations), the American company must pay the Japanese company in what currency? ___Japanese Yen____ In conducting this transaction, the American company ____demand____ Japanese Yen in the currency market and ____supply______ U.S.$. in that market. This currency __exchange__ would result in the __appreciation__ of the JY and the ____depreciation____ of the U.S.$. Movements in exchange rates affect the relative ___price___ of goods, services and assets. The Equilibrium Exchange Rate In the currency market, the country that is importing is ___supplying____ their own currency and __demanding___ another country’s currency. A country that is buying bonds __supplies___ their own currency and ___demands____ another country’s currency. When a country’s currency appreciates, their imports __rise__ and their exports fall. Now note that this next graph gets confusing. Take it one step at a time. Draw a Foreign Exchange Market graph in which $1 = JY 107.94. Include all labels. On this graph, show and label the effects of an increase in demand for U.S.$ by the Japanese to purchase U.S. bonds. What is the effect of this shift on the value of JY in relation to U.S.$? ___________________________________ What will be the effect of this change in currency valuation on the current account? ________________________________________ Now stop! Inflation and Real Exchange Rates What is the real exchange rate? How is it calculated? _____________________________________________________________________________ _____________________________________________________________________________ Why is the real exchange rate so much more valuable as data than the nominal exchange rate? _____________________________________________________________________________ _____________________________________________________________________________ Purchasing Power Parity What does this economic term mean and why is it useful? _____________________________________________________________________________ _____________________________________________________________________________ Why are price levels generally lower in developing countries than in developed countries? _____________________________________________________________________________ How does the Big Mac index show the value of PPP as a predictor of currency movements? _____________________________________________________________________________ _____________________________________________________________________________ How did the U.S. benefit from a week dollar starting around 2006? How did it help stabilize the economy? _________________________________________________________________ _____________________________________________________________________________ CYU 34-2 1. a. ________________________________________________________________ b. ___________________________________________________________________________ c. ___________________________________________________________________________ 2. a. _________________________________________________________________________ b. ___________________________________________________________________________ (p. 939) 6. Q1. _____________________________ Q2. ________________________________ 8. a. b. c. d. 9. a. b. 10. a.__________________b.___________________c._________________d.______________