ECON 101 Lecture Notes - Lecture 5: Crawling Peg, Currency Board, Money Supply
1 May 2018
School
Department
Course
Professor
Economics 101
Lori Leachman
Part 5 • Lecture
• Price elasticity
o Very important in pricing strategy - revenue maximization
o EP = %Qd / %P
▪ Elastic %Qd > %P
• TR increases when price falls
▪ Unit elastic %Qd = %P
• TR is at a maximum
▪ Inelastic %Qd < %P
• TR increases when price increases
• Exchange Rate Theory
o Exchange rates are determined through interaction with world thru activity in balance of payments
▪ CA + FA = [(x - m) + rn] + (Adom - ForA) = goods/services + stocks/bonds
o Foreign Price of home currency - european quote “per”
▪ E = # of FC units / $1
o Domestic Price of foreign currency (we use this) - american quote “in”
▪ e = $1 / # of FC units
▪ e increases
• HC is worth less in foreign money; HC depreciated/devalued
▪ e decreases
• HC is worth more in foreign money; HC appreciated/revalued
o Graph: e by FC units (based off of Foreign currency)
▪ DFC = f{ForAD, m} - we generate
▪ SFC = f{Adom, x} - they generate
• Demand is downward sloping because as e decreases, $ buys more so we import
more and buy more foreign assets
• Supply is upward sloping because as e increases, our own goods & assets are
cheaper so foreigners buy more of our exports and assets
• Exchange Rate Regimes
o Float - market sets the rate (market supply and demand)
▪ usually industrialized countries
o Fix - government sets rate and doesn’t change
▪ usually developing countries, small countries with 1 major trading partner, commodity
exporters
o In between
▪ Managed float - central bank intervenes sometimes
▪ Crawling peg - adjusts over time
▪ Crawling peg with variance bounds - adjusts over time within limits controlled by gov.
o Modern form of Fix exchange rate regime
▪ Currency board - local currency “backed” by another currency, gov. sets exchange rate
of domestic currency; only time new local units can be issued is if foreign assets enter
country
• Risk: large capital outflows decreases money supply
o Advantages of Float
▪ Price is the market price - the price is thus correct
▪ Independent monetary policy; have good existing monetary policy
▪ Buffers internal economy from external shocks (changes to offset great change) - less
domestic volatility
▪ Don’t need to hold many foreign currency reserves - few FC reserves
• US currency is the global vehicle currency; other countries hold US dollars in
banks
• 85% of world trade transactions is priced in dollars
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