International Trade
and Exchange Rates
Outline
•Balance of payments accounting
•Exchange rates—how are they determined?
•Exchange rates and the price of imported and
exported goods.
Balance of payments accounting
BOP accounting is the recording of transactions between
domestic and foreign economic agents.
Any transaction that results in a receipt of money by
domestic agents from abroad is recorded as a credit in the
BOP accounts.
Any transaction that entails the payment of money by
domestic units to foreigners is recorded as a debit in the
BOP accounts.
The current account records foreign transactions
involving merchandise and services.
The capital account records foreign transactions
involving financial assets and land.
An exchange rate is the price
of one national currency
expressed in terms of another national
currency. For example, the dollar
price of the British pound is $1.71-meaning it takes $1.71 to buy 1 pound
If the dollar price of the British pound is:
1.45 dollars = 1 pound
Then the pound price of the dollar is given by the
reciprocal of the dollar-pound exchange rate.
That is:
1
 0.69 pounds
Pounds per dollar =
1.44
Exchange Rates are Determined by the Supply
& Demand for Foreign Exchange
Supply of
euros
Dollars per Euro
1.15
Demand
for euros
0
E*
Euros
Why do agents want to
exchange dollars for euros ?
•To purchase European-made goods and
services.
•To purchase stocks in European companies
companies or other euro-denominated assets.
•To speculate on future exchange rate
movements.
Dollar Depreciates Against the Euro (and euro
appreciates against the dollar)
Supply of
euros
Dollars per Euro
1.30
1.15
D1
0
E*
D2
Euros
Currency Cross Rates New York Trading, July 25, 2003
Dollar
Canada
1.38
Euro Pound
Peso
Yen
Can.Dlr.
1.59
0.13
0.01
…
11.34
…
86.14
2.24
Japan
118.85 136.80 192.61
Mexico
10.48
12.06
16.99
…
0.09
7.60
U.K.
0.62
0.71
…
.06
0.005
0.97
Euro
0.87
…
1.41
.08
0.007
0.63
U.S.
…
1.15
1.62
.10
.008
0.72
Source: Wall Street Journal
Exchange Rates and the Prices of
Imported Goods
Question: Suppose the dollar
price of a new Harley
Davidson is $22,000. How
much would a German buyer
have to pay in euros?
Euro price of the Harley
Euro price = dollar price of the Harley × euro price of the dollar
Thus, at the current exchange rate (€ 0.87 = $1) we
have:
Euro price = $22,000 × 0.87 = € 19,140
An appreciating dollar makes
U.S.-made goods and services
less price-competitive
Example: Let the dollar appreciate
against the euro
The new exchange rate is € 1 = $1
Thus we have:
Euro price = $22,000 × 1.00 = €22,000
Exchange rates and the Affordability of
Imported Goods
The euro price of a Krups coffee maker
is €45.00
Question: What is the price of the
coffee maker expressed in dollars?
If the dollar price of one euro is
$1.15, then:
$Price = (1.15)(45) = $51.75
Effect of an appreciating dollar on the price of
imported goods
What if the dollar should appreciate, or
gain value, against the euro?
Let the dollar price of the euro to
decrease to $1.00 .
Question: What is the dollar price of
the Krups coffee maker?
$ price = (1.00)(45) = $45.00
The preceding examples
should make clear why those
who export goods or services
want a weak domestic
currency; whereas those who
purchase imports or travel
abroad prefer a strong
domestic currency.