Welcome to
EC 382: International
Economics
By: Dr. Jacqueline Khorassani
Week Ten
1
Week Ten: Class 1



Tuesday, November 6
14:10-15:00
AC 202
Some of you noticed that I did
not post the study guide until
last night
– Glad somebody noticed!
2
Collect Assignment
(OCA1)



Needs to be typed
It has 20 points
You work on this alone
– No duplicates
– Duplicates receive zero marks
3
Question 1
Visit the WTO’s web page at wto.org to
answer the following questions:
a) Is Iran a member of WTO? How about
Iraq?
b) Which country is the newest member of
WTO?
c) Is the following statement true or false?
Explain. “WTO is for free trade at any
cost.”
d) Is the following statement true or false?
Explain. “The voting power of a nation that
is a member of WTO depends on its GDP.”
e) What was the size of the WTO’s budget last
year?
4
Question 2
Search the web (or elsewhere) for at least
Two examples of countervailing
and/or antidumping duties imposed
by Ireland or Europe in the recent
years. Name the products and their
exporting countries and the nature of the
imposed duties. Clearly list your sources.
5
Last class


I gave you an ICA
Let’s look at it again
6
ICA 5: Find (1) merchandise balance, (2) goods and services
balance, (3) current account balance, (4) capital account
balance and (5) statistical discrepancy in Ireland
1.
2.
3.
4.
5.
6.
7.
Ireland exports €50 worth of shoes
A German tourist gets a hair cut in Galway
(€30)
Ireland imports €100 worth of TVs
Irish government sends €10 worth of aid to
Afghanistan
A Japanese buys €90 Irish government
bond
An Irish tourist goes to movies in Germany
(€15)
An Irish buys a €55 German bond.
7
Key to ICA5
1.
Merchandise Account has two items
in it
1. Ireland exports €50 worth of shoes
2. Ireland imports €100 worth of TVs
►
Merchandise Balance = 50-100
= -50
8
Key to ICA5
2. Goods and Services Account includes
merchandise account plus 2
additional items
1. A German tourist gets a hair cut in
Galway (€30)
2. An Irish tourist goes to movies in
Germany (€15)
►
Goods and Services Balance =
-50 + 30 – 15 = -35
9
Key to ICA5
3. Current Account includes goods and
services plus gifts
► Irish government sends €10 worth
of aid to Afghanistan
►
Current Account Balance = -35
-10 = - 45
10
Key to ICA5
4. Capital Account includes
1. A Japanese buys €90 Irish
government bond
2. An Irish buys a €55 German bond
►
Capital Account Balance = 9055=35
11
Key to ICA5
5. We know that Balance of Payments = 0
Current Account Balance + Capital Account
Balance +Statistical Discrepancy = 0
-45+35+Statistical Discrepancy = 0

Statistical Discrepancy= 10
12
CHAPTER 13
Exchange Rates
and Their
Determination:
A Basic Model
Note: See the Study Guide for the
topics you should know. If you have
a question, ask me.
13
What is the exchange
rate?


Value of one currency in terms of
another currency
Spot rate = rate for transaction on
spot
Is the exchange
rate flow or
stock?
14
Has dollar appreciated or
depreciated?

Yesterday the spot rate was
€1 = $1.43

Today the spot rate is
€1 = $1.53

Dollar has depreciated
15
What is the rate of
depreciation of dollar?
%Δ in Spot Rate =
Beginning Rate - Ending Rate
* 100
Beginning Rate
%Δ = (1.43-1.53)* 100 /1.43
= -7%
Dollar depreciated by 7%
16
Euros per Dollar: What is
causing these fluctuations?
17
Average yearly exchange
rate of euro








$1.0658
$0.9236
$0.8956
$0.9456
$1.1312
$1.2439
$1.2441
$1.2556
in
in
in
in
in
in
in
in
1999
2000
2001
2002
2003
2004
2005
2006
18
Demand and Supply Forces
Affect the Exchange Rate.

Foreign Exchange Market
1. Demand Curve

Shows the quantity demanded for a
currency by residents of another
country at different exchange rates.
2. Supply Curve

Shows the amount of a currency
supplied at a different exchange
rates.
19
Consider demand for euro
by Americans




Why will Americans demand euro?
To import European goods and
services
To buy European bonds/stocks
To sell the euros later or in a
different location for profits
20
The Demand for euro
$/€
$3
$2
$1
Demand
for Euros
€1
€2
€3
euros
21
Shifts: What if US GDP goes
up?
$/€
US income goes up 
Demand D1
D1
Demand for euros
D2
Euros
22
International Economics

Week Ten –Class 2
– Wednesday, November 7
– 11:10-12:00
– Tyndall
23
Shifts: What if US Prices go
down?
$/€
Americans buy
fewer European
goods  Demand
goes down D2
D1
Demand for euros
D2
Euros
24
Shifts: What if interest rates
in Europe go up?
$/€
US residents would
want to buy more
European bonds
Demand D1
D1
Demand for euros
D2
Euros
25
Consider supply of Euro
by Europeans




Why will Europeans supply euro?
To importers American goods and
services
To buy American bonds/stocks
To sell later or in the different location
for profits
26
The Supply of
Euros
$/€
Supply of
Euros
$3
$2
$1
€1
€2
€3
euros
27
Shifts: What if European’s
income goes up?
$/€
Europeans will want to
buy more American
goods  Supply of
euro goes up to S1
S2
Supply of Euros
S1
Euros
28
Shifts: What if Europeans expect
euro to appreciate further in the
will supply less now
near future? Europeans
Supply of euro goes down to S
2
$/€
S2
Supply of Euros
S1
Euros
29
Equilibrium in the
Foreign Exchange Market


Equilibrium Exchange:
– The exchange rate where the quantity
demanded of foreign exchange equals the
quantity supplied.
In our examples, the amount of euros U.S.
residents want to buy equals the amount of euros
Europeans want to sell.
30
Equilibrium Exchange Rate
$/Euro
Supply
of Euros
2.5
2.0
1.5
Demand
for Euros
100
200 300 400 500
Euros
31
What if Europe’s GDP goes
up?
Euro
$/Euro
Supply of
euro goes up
to S1
depreciates
Supply
of Euros
2.5
S1
2.0
1.5
Demand
for Euros
100
200 300 400 500
Euros
32
What if US prices go up
and EU prices don’t
Demand goes up
Euro
appreciates
because
Americans would
want to buy more
European goods
S1
$/Euro
Supply
of Euros
3.0
Supply
goes down
because
Europeans
buy fewer
American
goods
2.5
2.0
D1
1.5
Demand
for Euros
100
200 300 400 500
Euros
33
Are fluctuations in the
value of a currency good
or bad for the economy?

No surplus/ shortage
– Good
34
But fluctuations in the value of a
currency discourages international
trade or investment.





I order a US car today for $30,000
Delivery and payment in 6 months
In 6 months, what if $ appreciates against
euro?
I have to spend more euros than expected.
Uncertainty discourages international
trade
– Bias toward trade within a nation
35
But wait; there is a
solution

I can buy dollars in a forward market.
– Sign a contract today to buy $30,000 in
six months for €0.8 per dollar.

There is a fee involved
36
International Economics

Week Ten - Class 3
– Wednesday, November 7
– 15:10-16:00
– AC 201
37
Fluctuating exchange rates have
led to an industry of forecasters.

Need reasonably accurate forecasts
for country’s
– GDP
– Inflation
– Interest rate

The supply/demand model is good
for general comments about
exchange over the medium to long
run.
38
CHAPTER 14
Money, Interest
Rates, and the
Exchange Rate
39
What is money?
Anything that can be used for final
discharge a debt.

–
–
–
Credit card is not money
Balance in checking account is money
Coins and currency are money
40
What can money be used
for?
1)
Medium of Exchange

What is the main problem with
barter economy?
– It requires double coincidence
of wants.
2)
Unit of Account


Measure and compare values
Makes economic transactions
easier to compare
41
What can money be used
for?
3) Store of Value



Save now spend later
Smoothes inconsistencies
between money earned and
money spent
Note: Individuals in high inflation
countries my keep other
currencies or goods as a store of
value.
42
What is the Supply of Money?


Coins and paper currency act as
primary mediums of exchange –
money.
Demand deposits held at banks and
depository institutions provide the
same function as currency – money.
43
The Supply of Money

M1:
 Is
total quantity of currency plus
demand deposits (narrow money,
internationally).
There are broader measures
of money such as M2,
M3,…etc. They include other
(less liquid) assets.
 M1<M2<M3

44
What is Monetary Base (B)?

Cash held by the public (C) and the
total quantity of bank reserves (R)
on deposit at central bank
B = C +R
45
What is Reserve Requirement?

The percentage of deposits (r)
banks are legally required to keep
on deposit with the central bank
46
What is Money Multiplier
(MM)?

The reciprocal of the reserve
requirement
MM = 1/r


Money supply (M1) is equal to the
monetary base multiplied by the
money multiplier.
MS = M1 = 1/r * B
47
Example






€80 = Cash in hands of the public
€230 = Bank Reserve
Required reserve = 0.1
What is MS?
MS = 1/0.1 * (310)
MS = 3100
48
Monetary policy
Refers to central bank changing
money supply by changing the
monetary base and/or the money
multiplier.
 MS = M1 = 1/r * B
MS↑ if
B↑ or if
r↓
49
How can the central bank
change B or r?
1.
Change the interest rate banks
pay on borrowed money from the
central bank
 Discount Rate (US), Marginal Lending
rate (Europe):
 Lower interest rate  increase in
borrowed reserves  B↑  MS↑
50
How can the central bank
change B or r?
2. Changing reserve requirement (r):
 Lower reserve requirement
means banks could make more
loans.
– If r↓  MM↑ MS↑

Rarely used b/c effect too powerful
51
How can the central
bank change B or r?
3. Open Market Operations,
refinancing :


Buying and selling bonds by
central bank
If the central bank buys bonds,
money is given to bond seller
(public or bank) and more
money is in the economy 
B↑ MS↑
52
Money Supply Curve
Controlled by the central
bank
Interest Rate
(i)
MS2
Money
Supply
(MS)
MS
1
Contractionary
Expansionary
monetary
monetary
policy
policy
Money (M1)
53