Textbook Notes (362,734)
Canada (158,032)
Economics (293)
ECON 291 (14)
Chapter 10

Chapter 10

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Simon Fraser University
ECON 291
Alfred Kong

Econ 291 Chapter 10101 Exchange Rates The nominal exchange rate answers the question how many units of a foreign currency can I get in exchange for on unit of my domestic currency The real exchange rate answers the question How many units of the foreign good can I get for my domestic goodNominal exchange rate e The number of units of foreign currency that can be purchased with one unit of the ndomestic currency two currencies can be traded o It is the rate at whichften simply called the Exchange rateFlexible Exchangerate system the current system for major currencies the exchange rates are not held fixed instead they are determined by supply and demand and may change every dayNominal depreciation e falls a dollar buys fewer units of foreign currencynNominal Appreciation e rises a dollar can buy more units of foreign currencynfixedexchangerate system In the past exchange rates were determined by governments and thus they were fixed because the central banks in those countries offered to buy or sell the currencies at the fixed exchange rate even today some smaller countries fix their exchange ratesDevaluation a weakening of the currencyRevaluation a strengthening of the currencyWe also use the terms real appreciation and real depreciation to refer to changes in the real exchange rateReal exchange rate e how much of a foreign good you can get in exchange for one unit of a domestic good Eg how many dollars does it take to purchase a good in japan In the real exchange rate the price level of the country is taken into account thus it measures the price of domestic goods relative to foreign goodsee PP nFP foreign goods price P domestic goods priceFPurchasing power parity PPP If there were no transportation costs the real exchange rate would have to be e1 or else everyone would buy goods where they were cheaper So Setting e1 rearrange the equation and the nominal exchange rate equals the foreign price level divided by the domesti
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