Foreign Exchange Market and International Trade Notes

Foreign Exchange

• It is the buying and selling of currency.
• The exchange rate (e) is determined in the currency markets
• Current exchange is 77 Japanese Yen to 1 dollar.
• The exchange rate is the price of a currency.
• Do not try to calculate the exact exchange rate.

Tips

• Always change the D line on the one currency graph, the s libe on the other's currency graph
• Move the lines of the two currency graphs i the same direction (right or left) and you will have the correct answer
• If D on one graph increases, S on the other will increase too
• If D moves left to the left, S will move to the left on the other graph.

Changes in the Exchange Rate

• Exchange rates (e) are a function of the supply and demand for currency.
• An increase in the supply of a currency will make it cheaper to buy one unit of that currency.
• A decrease in supply of a currency will make it more expensive to buy one unit of that currency.
• An increase in the demand of a currency will make it more expensive to to buy one unit of that currency.
• A decrease in demand of a currency will make it cheaper buy one unit of that currency.

Dollar Market Graph


Appreciation

• Appreciation of a currency occurs when the exchange rate of that currency increases.
• 100 Yen used to buy $1, now 200 Yen buys $1
• The dollar is stronger because one buys more Yen than it used to.

Depreciation

• Occurs when the exchange rate of that currency decreases
• 100 Yen used to buy $1 now 50 Yen buy $1
• The dollar is weaker because it takes fewer Yen to buy one dollar.

International Trade

Purchasing Power Parity

• When currency rate are set by international market, changes will be based o the purchasing power of the currency
• If US dollar to the European Euro is 1.5 to 1, then each $1.50 will buy one euro. However if a item in US cost a $1.50 and then cost more or less than one euro, the parity is lost.
• Markets will adjust quickly in floating rates or pressure for change will occur in fixed rates.

Why do we exchange currencies?

• To sell export and buy imports.
• To invest in another country's stocks and bonds.
• To build stores or factories in another country.
• To speculate on currency values
• To hold currencies in bank accounts for future exports, imports and business loans.
• To control excessive imbalances.

Unit 7 Notes

Balance of Payments

• Measure of money inflows and outflows between the US and the rest of the world (ROW)
• Inflows: Credit *adding
• Outflows: Debits *taking
• The balance of payments is divided into 3 accounts
• Current Account
• Capital/Financial Account
• Official Reserves Account

Double Entry Bookkeeping

• Every transaction in the balance of payment is recorded twice in accordance with standard accounting practice
• Ex: US manufacturer John Deere exports $50 million worth of farm equipment to Ireland
• A credit of $50 million to the current account 
• A debit of $50 million to capital/financial

Current Account

• Balance of trade or net exports
• Exports of goods/services -import of goods/service
• Exports create a credit to the balance of payments
• Imports create a debit to the balance of payments
• Net Foreign Income
• Income earned by US owned foreign assets - Income paid to foreign held US assets
• Ex: Interest Payments on US owned Brazilian bonds - Interest payments on German owned US Treasury bonds.
• Net Transfers (tend to be unilateral)
• Foreign Aid -> A debit to the current account
• Ex: Mexican migrant workers send money to family in Mexico

Capital/Financial Account

• The balance of capital ownership
• Includes the purchase of both real and financial assets
• Direct Investment in the US is a credit to the capital account
• Ex: The Toyota Factory in San Antonio
• Direct investment by US firms/individuals in a foreign country are debits to the capital account
• Ex: The Intel Factory in San Jose, Costa Rica
• Purchase of foreign financial assets represents a debit to the capital account
• Ex: Warren Buffet buys stock in Petrochina
• Purchase of domestic financial assets by foreigners represents a credit to the capital account.
• The United Arab Emirates sovereign wealth fund purchase a large stake in the NASDAQ

Relationship between Current and Capital Account

• The current Account and the Capital Account should zero each other out.
• That is if the Current Account has a  negative balance (deficit), then the Capital Account should than have a positive balance (surplus)
• Example: The constant net inflow of foreign financial capital to the United States (capital account) is what enables us to import more than we export(current account deficit)
• Official Reserves
  • The foreign currency holdings of the United States Federal Reserves System
  • When there is a balance of payments surplus the Fed accumulates foreign currency ad debits the balance of payments.
  • When there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments.

  Active v. Passive Official Reserves
  • The United States is passive in its use of official reserves. It doesn't seek to manipulate the dollar exchange rate.
  • The People's Republic of China is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate with the United States.

Unit 5 Notes

Relating Phillips Curve to AS/AD

• Changes in the AS/Ad model can also be seen in the Phillips Curves
• Almost like mirror images
• Two models are not equivalent. The AS/AD model is static but the Philips Curve includes changes over time, while the AS/AD shows one time changes in the price level as inflation or deflation. 
• The Phillips curve illustrates continuous change in the price-level as either increased inflation or disinflation .

Stagflation: rising inflation and rising unemployment

• Civil right movement
• Women's movement
• Baby boom 1946 1964
• When Vietnam ended
• Embargo 1973 - 1979

Disinflation

• Reduction in inflation rate from year to yer which is usually displayed in the LRPC
• This occurs when AD declines
• In short run profits fall and the unemployment rate increases

Deflation

• Actual drop in the price level

Laffer Curve

Supply side economics

• Supply side economist tend to believe that the AS curve will determine levels of inflation, unemployment and economic growth
• To increase the economy, you take action to shift the AS curve to the right, always benefitting the company first. 
• Focus on marginal tax rate ( amount paid on the last dollar earned or on each additional dollar)
• Reduction in marginal tax rate, you encourage more people to work longer in which they would for go their leisure time for extra income.
• Lowered taxes are an incentive for businesses to invest in our economy.
• Lowered taxes are incentives for people to increase savings and therefore create lower interest rates for increases in business investments.
• Reaganomics: lowered marginal tax rate to get US out of recession and caused a deficit.

Laffer Curve

It is a trade off between tax rates and goverment revenue 

Used to support the supply side argument

As tax rates increase from 0, tax revenues increase from 0 to some maximum level and then decline.

Criticisms of the Laffer Curve 

Research suggests that the impact on tax rates on incentives to work, save and invest are small.

Tax cuts also increase demand which can fuel inflation which will cause demand to exceed supply.

Where the economy is actually located on the curve is difficult to determine.

Monetary Policy Video

Relating the Money Market, Loanable Funds Market, and AD-AS

AP Macroeconomics Unit 4 Part 9

The first two graphs, are the same as before, and should be labeled exactly the same. For the AD-AS graph, the y-axis should be labeled as price level and the x-axis should be labeled as GDP. To show a change through the money market graph all the way over to the AD-AS graph, you must start at the money market graph. 

If there is an increase in demand for money, the interest rate will boost up. You can show that on the loanable funds graph in two ways. There can either be an increase in demand for loanable funds or reduce the supply of loanable funds. Say you use the idea to increase the demand for loanable funds, the graph would shift to the right and the interest rate and equilibrium would be the same for the two graphs. An increase in government spending will increase aggregate demand. An increase in AD also increases the price level and GDP. 

Money Creation and Multiple Deposit Expansion

AP Macroeconomics Unit 4 Part 8

              Banks create money by making loans. To calculate how much money is created, you must know use the money multiplier, which is 1/ Required Reserves. If a loan is given out at the amount of $500 and the required reserve is at 20%, you would first use the money multiplier. Plug in 1/ .20 which equals 5 and multiply that by the amount of loans, $500. The amount of money created is $2,500. One thing to remember is, just because the bank loans out $500, it is not guaranteed to increase into $2,500. Banks can hold their excess reserves and prevent the increase of money.

The Loanable Funds Market

AP Macroeconomics Unit 4 Part 7

               First when making your graph, label the axis. Your y-axis should be labeled as interest rate. On the x-axis, it should be labeled as quantity of loanable funds. The demand for loanable funds is downward sloping, because when interest rate is lower, people demand for more money and when the interest rate is higher, people have a disincentive to borrow. The supply for loanable funds slope is upward sloping.

             The supply of loanable funds come from the amount of money people have in banks, which means that it is dependent on savings. If people have incentives to save more, the supply of loanable funds increases and shifts to the right and if the incentive is to save less, the supply of loanable funds would shift to the left. When the demand for money goes up, it is best to increase the demand for loanable funds so the equilibrium will be the same. To shift the demand curve for an increase, you would move it to the right and for a decrease the curve will be shifted to the left.