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Lecture 10

ECON 1BB3 Lecture Notes - Lecture 10: Canadian Dollar, Substitute Good


Department
Economics
Course Code
ECON 1BB3
Professor
Bridget O' Shaughnessy
Lecture
10

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What determines the value of the dollar?
11/7
Exchange rates
- Nominal exchange rate
oThe rate at which you can exchange one currency for another
- “e
oHow much foreign currency you can purchase with $1 canadian dollar
-e goes up
o$CAD appreciates stronger
oCheaper imports for consumers
-e goes down
o$CAD depreciates weaker
oIncrease in exports for firms
Real exchange rate
- The rate at which you can exchange goods and service between countries
RER = (nominal ER * domestic price) / foreign price = eP / P*
How are exchange rates determined?
- Purchasing-power parity (PPP)
oA unit of currency should buy the same quantity of goods in any country
How are exchange rates determined?
- We can rearrange the equation
How are exchange rates determined?
- Arbitrage
oTaking advantage of differences in prices in different markets AT THE SAME TIME to make
profit (not the same as buying a stock hoping for a capital gain – speculation)
- PPP tends to “work” (explain movement in nominal exchange rates) in the long run or in countries with
very different price levels
Limitations of PPP
- PPP doesn’t always work because:
1. Some goods are non-traded
2. Traded goods are not perfect substitutes
3. Transportation costs
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