Lecture 6

Part 1: World market- No Trade

 Two
countries: Home and foreign
 There is no trade
 Wheat
 No shipping costs
 Only difference is price
o Where two lines meet: Equilibrium
o That will be the quantity and price of the product in the market
 The equilibrium price is cheaper in Foreign market
 Home country
o Why don’t we make a trade and get the goods for cheaper?
o We could also make a free trade agreement (FTA)
o FTA could hurt the businesses in your home country
 Foreign country
o Why trade?
o They would be able to sell it in a higher price
o Industry will grow
o There will be competition

Part 2: World Market- Trade

  Home market
o They wouldn’t be willing to pay more for a product in foreign market
o As the price for imports go down, demand goes up.
o PFA is the floor price
o Foreign market fills the gap between the demand and supply in Graph 1 at
the PW
o Prices went up
 Demand- Happy
 Suppliers- Not happy
 Foreign
o Why should I sell it at a lower price (PFA ) when I can sell it at (Graph 2- PW )
o Foreign market has a surplus.
o That surplus is equal to the gap in graph 1.
o Prices went up
 Demand- not happy
 Suppliers- Happy
 Next step: Put tariffs on wheat.

Part 3: World Market- Trade with a Tariff

 Tariff depends on how big the economies are.

 Tariff is a barrier for trade.
 Home market isn’t affected by the tariff.
 Home markets imports go down.
 There is still a gap but not as much as before. They will import less.
 Foreign market will get their surplus and export it to the home market.
 Imposing tariffs: Creates a sense that no one’s happy, they are better off than they
were 10 years ago.

Exchange Rate Topics:

 Terminology:
o Direct quote: How much does it cost in my currency to get a foreign currency
 To get 1 euro, how much CAD should I give.
 o Indirect: I have one, how much that is going to get me in the foreign currency
 I have 1 CAD, how much euros I can get with it.
o Bid Rate: Dealer is willing to buy it from you
o Ask Rate: Dealer is willing to sell to you
 Difference between bid and ask is the profit: The Spread
o Arbitrage: Riskless profit. Finding free money
 Geographic arbitrage
 No additional cost
 Two rates
o NY: 2USD/ 1GBP
o London: 1.8 USD/ 1 GBP
 Exchange 1 GBP for 2 USD in NY, sell 2 USD in London, gain
1.11 G
 You do it as much as you can and as fast as you can until it
reaches an equilibrium price.
o Floating exchange rate: Exchange rate moves around.
o 7-8 years ago CAD was better than US. So when you go shopping in US, you
could buy more.
o Every 1 USD you can get 1.3 CAD
o 1.3 USD/CAD means  1.3 USD/ 1 CAD
 Measuring a change in exchange rates
o Midterm: no formula sheet.
 Base foundation formula:

 (1.31705-1.1159)/ 1.1159 = 0.180258x 100 =18%

o Beginning- Ending/ Beginning (Standard way)
o You can also do Ending- Beginning/ Ending
 But you have to inverse the rates.