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The Nominal Exchange Rate is 11 Mexican Pesos for 1 US Dollar A bottle of vanilla in the US is $15 A bottle of vanilla in Mexico is 140 Pesos Do the following to calculate the Real Exchange Rate: Converting US price to foreign currency, you have: _$15 * 11 = 165 pesos_ Spending that foreign currency in the foreign country, you can buy how many goods: _165 / 140 = 1.18 = real exchange rate_ Is the real exchange ( greater than / less than ) one? Because of this, people in the US should buy ( US / Foreign ) goods Because of this, people in the Foreign country should buy ( US / Foreign, their own) goods If people spend as suggested above, what will that cause? Price in US will fall (no one is buying US goods) Price in Mexico (Foreign) will rise (everyone is buying it) Real exchange rate will fall (because of the price changes) What would prevent the real exchange rate from moving as predicted above? There could restrictions on importation of vanilla (contains a lot of alcohol) Could be expensive to transport Quality differences: Mexican vanilla is inferior to domestic (in truth, Mexican vanilla is often vanilla). If NER went to 12 pesos per dollar, we would say the dollar ( appreciated / depreciated ) Consider the following transactions: The US buys $150 million of electronics from China China buys $80 million of stock in Cisco The US builds an iPod factory in China at a cost of $30 million China buys $120 million of SUV’s from the US The US buys $60 million of clothing from China China buys $30 million of real estate in the US What is the US trade balance? = $120 (export of SUV’s) - $150 (import electronics) - $60 (import clothing) = - 90 million What is US Net Capital Outflow? = - 90 million easiest way to get this is to use that Trade Balance = NCO What is China’s trade balance? = + 90 million This must be the opposite (in sign) from US trade balance How much is China’s portfolio foreign investment in the US? China’s portfolio investments: $80 million stock $30 million real estate $10 million US money (if you work through all the exchanges above, China ends up acquiring an additional $10 million of US money) =$120 million Population = 95 million # people working = 40 million # people searching for work = 5 million What is the unemployment rate? = 5 / 40 + 5 = 1 / 9 = .11 = 11%