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EC1301PRINCIPLESOFECONOMICS AcademicYear2010/2011,SemesterI InternationalTrade&Finance 1. ThedemandandsupplyforSwissfrancsaregiveninthetablebelow. QuantityofSwissFrancs Price QuantityofSwissFrancs Supplied Demanded 800 $1.20 200 700 $1.

$1.15 400 600 $1.10 600 500 $1.05 800 400 $0.95 1000 300 $0.90 1200 200 $0.85 1400 a. WhatwillbetheexchangeratefortheSwissfrancandtheU.S.dollar? Aeurowillcost$1.10. OneU.S.dollarwillbuy0.91euros. b. What would happen if the U.S. and Swiss governments wanted to fix or pegthepriceofaSwissfrancatUS$0.95? The governments would have to sell 600 euros to meet the quantity demanded. 2. Economicsdemonstratesthatopeningupunrestrictedfreeinternationaltrade isbeneficialtoallnations.However,arethereanylosersfromsuchapolicy change? Yes,therearelosersfromopeninguptofreetrade.Domesticsuppliersof importedgoodslosefromallowingfreetrade.Ownersofthebusinesses loseasdoworkerswhohadjobsintheimportcompetingindustries. However,itisimportanttorealizethatalthoughtherearelosersfromfree trade,therealsoaresubstantialgainsandthegainsexceedthelossessothat thenationasawholeismadebetteroffwithfreetrade. 3. Isitpossibletoexportservices?Ifso,givesomeexamples.Ifnot,explainwhy not. Itispossibletoexportservices.Exportsofservicesincludepaymentsfor transportationofgoodsbydomesticcarriers(suchasthepaymentmadetoa 1

SingaporecouriercompanyforshippingparcelsbetweenJapanand Thailand). Country Exports(billionsofdollars) Imports(billionsofdollars) France 100 80 Korea 50 44 Mexico 110 115 Peru 30 35 4. AcountrytradeswithonlyFrance,Korea,MexicoandPeru.Thetableabove hasinformationaboutthenationstrade.Whatisthebalanceoftradewith eachcountryandtheoverallbalanceoftrade? ThecountryhasatradesurpluswithFranceof$20billion,atradesurplus withKoreaof$6billion,atradedeficitwithMexicoof$5billionanda tradedeficitwithPeruof$5billion.Itsoveralltradebalanceisatrade surplusof$16billion.

5.

Ifthedollardepreciates,whatistheeffecton a. aggregatedemand? Exportsincreaseandthus,aggregatedemandincreases. b. thepricelevel? Thepricelevelrises.

6.

ThepriceofacomputerintheUnitedStatesis$1,000.Thepriceofacarin Germanyis10,000euros.Thecurrentexchangerateis0.9eurosperdollar. a. IfacomputerisexportedfromtheUnitedStatestoGermanywithno barrierstotrade,whatwillbethepriceofthecomputerinGermany? ThepriceofanAmericancomputerinGermanyis$1,0000.9euros perdollar,whichis900euros. b. IfacarisimportedtotheUnitedStatesfromGermanywithnobarriers totrade,whatwillbethepriceofthecarintheUnitedStates? ThepriceofaGermancarintheUnitedStatesis10,000euros0.9 eurosperdollar=$11,111.

c.

Supposethedollarappreciatesby10percentagainsttheeuro.How willthepriceofacomputerexportedfromtheUnitedStateschangein Germany? Thenewexchangerateis0.9eurosperdollar1.1=0.99eurosper dollar.SothenewpriceofaU.S.computerinGermanyis$1,000 0.99eurosperdollar=990euros.ThepriceofaU.S.computerin Germanyrisesby10percent. Supposethedollarappreciatesby10percentagainsttheeuro.How willthepriceofacarimportedtotheUnitedStatesfromGermany changeintheUnitedStates? ThenewpriceofaGermancarintheUnitedStatesis10,000euros 0.99eurosperdollar=$10,101.ThepriceofaGermancarinthe UnitedStatesfallsbyabout10percent.

d.

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Intheforeignexchangemarket,whatfactorleadstoamovementalongthe demandcurvefordollars? Achangeintheexchangerateleadstoamovementalongthedemandcurve fordollars.

8.

WhydopeopleandfirmsintheUnitedStatessupplydollarstotheforeign exchangemarket? Peopleandfirmssupplydollarsinordertoobtainforeigncurrencywith whichtopurchaseforeigngoodsandservicesand/orforeignassets.

9.

Intheforeignexchangemarket,howdoesafallintheU.S.interestrateaffect thesupplyofdollars? ThefallintheU.S.interestrateincreasesthesupplyofdollarsasU.S. residentssupplymoredollarsinordertoobtainforeigncurrencywith whichtobuyforeignassetsthatnowhaverelativelyhigherinterestrates.

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Intheforeignexchangemarket,ifthedemandfortheU.S.dollarincreases, theU.S.dollarappreciatesinvalue.Brieflyexplainwhethertheprevious statementiscorrectorincorrect. Thestatementiscorrect.Theincreaseinthedemandfordollarsshiftsthe demandcurvefordollarsrightwardandcreatesashortageofdollarsatthe initialexchangerate.Thisshortageputsupwardpressureontheexchange rateandsotheexchangeraterisestoitsnewequilibriumvalue. Supposethatthefreemarketexchangerateforthedollaris115yen,butthe U.S.andJapanesegovernmentswantittobe120yen/dollar.Whatcanthe governmentsdo?Illustrateyouranswerwithagraph.

Asshowninthegraph,theinitialdemandandsupplyforthedollar intersectatanexchangerateof115yen/dollar.Inordertoraisethepriceof thedollar,thegovernmentsneedtoincreasethedollar(showninthegraph asarightwardshiftinthedemandcurve).Theywoulddothisbyselling yenfordollarsuntiltheexchangeraterisestothedesiredlevelof120 yen/dollar.