International Trade and Exchange Rates

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International Trade and Exchange Rates

• Outline
• Balance of payments accounting
• Exchange rateshow are they determined?
• Exchange rates and the price of imported and
  exported goods.

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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.

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Exchange Rates
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
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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 Pounds per
dollar
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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
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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.

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Dollar Depreciates Against the Euro (and euro
appreciates against the dollar)
Supply of euros
Dollars per Euro
1.30
1.15
D2
D1
0
E
Euros
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Currency Cross Rates New York Trading, July 25,
2003
Source Wall Street Journal
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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?
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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
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An appreciating dollar makes U.S.-made goods and
services less price-competitive
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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
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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
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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
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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.