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EC140 (329)
Chapter 25

Chapter 25 EC140.docx

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Department
Economics
Course
EC140
Professor
Angela Trimarchi
Semester
Fall

Description
EC140 Chapter 25 – The Exchange Rate and the Balance of Payments Week 4 Currencies and Exchange Rates -Foreign currency is the money of other countries regardless of whether that money is in the form of notes, coins, or bank deposits The Foreign Exchange Market -The market in which the currency of one country is exchanged for the currency of another -Made up of thousands of people – importers and exporters, banks, international travellers, and specialist traders called foreign exchange brokers -The sun barely sets on the foreign exchange market -Starts opening in Sydney and Hong Kong and then rotates from there until they are open in all countries Exchange Rates -The price at which one currency exchanges for another currency in the foreign exchange market -The exchange rate fluctuates -A rise in the exchange rate is called an appreciation of the dollar and a fall in the exchange rate is called a depreciation of the dollar -The quantity of foreign money that we can buy with our dollar changes when the dollar appreciates or depreciated Nominal and Real Exchange Rates -The nominal exchange rate is the value of the Canadian dollar expressed in units of foreign currency per Canadian dollar -The real exchange rate is the relative price of Canadian-produced goods and services to foreign produced goods and services -The real exchange rate equals the nominal exchange rate multiplied by the ratio of the Canadian price level to the foreign price level -The real exchange rate changes if the nominal exchange rate changes and prices remain constant Canadian-Dollar Effective Exchange Rate Index -An average of the exchange rates of the Canadian dollar against the U.S. dollar, the European Union euro, the Japanese yen, the U.K. pound, the Chinese yuan and the Mexican peso -In the CERI, each currency gets a weight that represents the importance of the currency in Canada’s international trade EC140 Chapter 25 – The Exchange Rate and the Balance of Payments Week 4 The Foreign Exchange Market -An exchange rate is determined in a market – the foreign exchange market -The foreign exchange market has many traders and no restrictions on who may trade – it is a competitive market -Demand and supply determine the price The Demand for One Money is the Supply of Another Money -When people want to exchange a foreign currency for Canadian dollars, they demand Canadian dollars and supply that other currency and vice versa Demand in the Foreign Exchange Market -People buy Canadian dollars so they can buy Canadian produced goods and services, bonds, stocks, businesses and real estate -The quantity demanded of Canadian dollars depends on: -The exchange rate -World demand for Canadian exports -Interest rates in Canada and other countries -The expected future exchange rate The Law of Demand for Foreign Exchange -The higher the exchange rate, the smaller is the quantity of Canadian dollars demanded in the foreign exchange market -The exchange rate influences the quantity of Canadian dollars remanded for two reasons: -Exports effect -Expected profit effect Exports Effect -The value of Canadian exports depends on the prices of Canadian-produced goods and services expressed in the currency of the foreign buyer -If the exchange rate falls, the quantity of Canadian dollars demanded in the foreign exchange market increases Expected Profit Effect -The larger the expected profit from holding Canadian dollars, the greater is the quantity of Canadian dollars demanded in the foreign exchange market -For a given expected future exchange rate, the lower the exchange rate today, the larger is the expected profit from buying Canadian dollars today and holding them, so the greater quantity of Canadian dollars demanded in the foreign exchange market today Demand Curve for Canadian Dollars -A change in the exchange rate, brings a change in the quantity of Canadian dollars demanded and a movement along the demand curve EC140 Chapter 25 – The Exchange Rate and the Balance of Payments Week 4 Supply in the Foreign Exchange Market -People sell Canadian dollars and buy other currencies so they can buy foreign-produced goods and services, foreign bonds, stocks, businesses and real estate -The quantity supplied of Canadian dollars in the foreign exchange market depends on: -The exchange rate -Canadian demand for imports -Interest rates in Canada and other countries -The expected future exchange rate The Law of Supply of Foreign Exchange -The higher the exchange rate, the greater is the quantity of Canadian dollars supplied in the foreign exchange market -The exchange rate influences the quantity of dollars supplied for two reasons: -Imports effect -Expected profit effect Imports Effect -The value of Canadian imports depends on the prices of foreign-produced goods and services expressed in Canadian dollars. These prices depend on the exchange rate -The higher the exchange rate, other things remaining the same, the lower are the prices of foreign- produced goods and services to Canadians and the greater are Canadian imports Expected Profit Effect -The higher the exchange rate today, the larger is the expected profit from selling Canadian dollars today and holding foreign currencies, so the greater is the quantity of Canadian dollars supplied Supply Curve for Canadian Dollars -A change in the exchange rate, brings a change in the quantity of Canadian dollars supplied and a movement along the supply curve EC140 Chapter 25 – The Exchange Rate and the Balance of Payments Week 4 Market Equilibrium -Equilibrium in the foreign exchange market depends on how the Bank of Canada and other central banks operate -The exchange rates act as a regulator of the quantities demanded and supplied -If the exchange rate is too high there is a surplus and if the exchange rate is too low there is a shortage –The foreign exchange market is constantly pulled to its equilibrium by the forces of supply and demand Changes in Demand and Supply: Exchange Rate Fluctuations A Change in Demand for Canadian Dollars -The demand for Canadian dollars in the foreign exchange market changes when there is a change in: -World demand for Canadian exports EC140 Chapter 25 – The Exchange Rate and the Balance of Payments Week 4 -Canadian and foreign interest rates -The expected future exchange rate World Demand for Canadian Exports -An increase in world demand for Canadian exports increases demand for Canadian dollars Canadian and Foreign Interest Rates -People buy financial assets to make a return. The higher the interest rate that people can earn on Canadian assets compared with foreign assets, the more Canadian assets they buy The Expected Future Exchange Rate -A rise in the expected future exchange rate increases the profit that people expect to make by holding Cana
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