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Economics 1022A/B Lecture Notes - Lecture 18: Foreign Exchange Market, Demand Curve, Interest Rate Parity

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School
Western University
Department
Economics
Course
Economics 1022A/B
Professor
Macdonald

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ECON 1022A/B verified notes
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17

Economics 1022A/B Lecture Notes - Lecture 17: Foreign Exchange Market, Demand Curve, Canadian Dollar

18

Economics 1022A/B Lecture Notes - Lecture 18: Foreign Exchange Market, Demand Curve, Interest Rate Parity

19

Economics 1022A/B Lecture Notes - Lecture 19: Aggregate Supply, Potential Output, Longrun

Document Summary

At a given current exchange rate, if the expected future exchange rate for. Canadian dollars rises, the supply of canadian dollars decreases and the demand curve for dollars shifts leftward. If demand for canadian dollars increases and supply does not change, the exchange rate rises. If demand for canadian dollars decreases and supply does not change, the exchange rate falls. If supply of canadian dollars increases and demand does not change, the exchange rate falls. If supply of canadian dollars decreases and demand does not change, the exchange rate rises. Arbitrage is the practice of seeking to profit by buying in one market and selling for a higher price in another related market. Arbitrage in the foreign exchange market and international loans and goods markets achieves four outcomes: The law of one price states that if an item can be traded in more the one place, the price will be the same in all locations.

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Related Questions

23) Which of the following factors move the demand curve for Canadian dollars and the supply curve of Canadian dollars in opposite directions? A) The interest rate differential increases or decreases. B) Canadian imports increase or decrease. C) The world demand for Canadian exports increases or decreases. D) The expected future exchange rate rises or falls. E) Both A and D above

1. What happens when the price level rises?
a. The value of money rises, and exchange rates and interest rates also rise.
b. The value of money rises, while exchange rates and interest rates fall.
c. The value of money falls while exchange rates and interest rates rise.
d. The value of money falls, and exchange rates and interest rates also fall.


2. Which of the following best describes what happens when the price level rises?
a. Households increase foreign bond purchases, and the supply of dollars increases.
b. Households increase foreign bond purchases, and the supply of dollars decreases.
c. Households decrease foreign bond purchases, and the supply of dollars increases.
d. Households decrease foreign bond purchases, and the supply of dollars decreases.


3. In which of the following situations does investment spending increase?
a. when the price level rises, causing interest rates to rise
b. when the price level rises, causing interest rates to fall
c. when the price level falls, causing interest rates to rise
d. when the price level falls, causing interest rates to fall

4. If a government started with a deficit and moved to a surplus, which of the following best describes the
effects of these changes?
a. Domestic investment and the real exchange rate would rise.
b. Domestic investment and the real exchange rate would fall.
c. Domestic investment would rise, and the real exchange rate would fall.
d. Domestic investment would fall, and the real exchange rate would rise.

5. Suppose the economy is in long-run equilibrium. In a short span of time, there is a sharp increase in the
minimum wage. In the short run, what would we expect to happen?
a. the price level to rise, and real GDP to fall
b. the price level to fall, and real GDP to remain unchanged
c. the price level to remain unchanged, and real GDP to fall
d. the price level to fall, and the real GDP to rise the same

Assume that the U.S. dollar and the Japanese yen are the only two currencies in the world.

a. A bilateral nominal exchange rate S is the spot (now) exchange value of one currency in terms of the other and S can be written as dollars per 1 yen or yen per 1 dollar. If S = yen/1 dollar = 76.92 then the inverse 1/S gives dollars per 1 yen where 1/S = 1/(yen/1 dollar) = 1/76.92 = .013. If the 1/S increases to .014, has the dollar appreciated (1 dollar is worth more yen) or depreciated (1 dollar is worth less yen)? Explain.

b. Changes in demand and supply in the foreign exchange (FX) market determine the value of floating exchange rates S. If S is expressed as S = yen/1 dollar, then we have the FX market in terms of the demand and supply of dollars. (If S = dollars/1 yen, then we get the FX market in terms of the demand and supply of yen. Note also that no matter which currency the FX market is expressed, it is still an FX market where dollars are exchanged for yen. This means that an upward-sloping supply of dollars curve is exactly the same as a demand for yen curve and a downward-sloping demand for dollars curve is exactly the same as a supply of yen curve). Using S = yen/1 dollar and the FX market in terms of the demand and supply of dollars, an increase in S (dollar appreciation) leads to an increase in the number of dollars supplied (increase in the quantity of yen demanded). For dollar demand (or the supply of yen), an increase in S (dollar appreciation) leads to a decrease in the number of dollars demanded (or an increase in the number of yen supplied). The dollar demand curve shifts to the right if more yen are offered for dollars at any exchange rate S. An increase in dollar demand is caused mostly by private sector transactions in the current and capital accounts. Either an increase in demand for U.S. goods (merchandise trade in the current account) or an increase in demand for U.S. stocks and bonds (capital account inflows) will shift the dollar demand curve to the right. If private transactions in the current and capital accounts also cause shifts in the dollar supply curve, what are the corresponding factors that would lead to an increase in dollars supplied (yen demanded) at any exchange rate S?