1. The Price Adjustment Mechanism with Flexible and Fixed Exchange Rates
Lecture 5
The Price Adjustment Mechanism
with Flexible and Fixed Exchange Rates

2. Chapter 16 The Price Adjustment Mechanism with Flexible and Fixed Exchange Rates
16.1 Introduction
16.2 Adjustment with Flexible Exchange Rates
16.3 Effect of Exchange Rate Changes on Domestic Prices and the Terms of Trade
16.4 Stability of Foreign Exchange Markets
16.5 Elasticities in the Real World
16.6 Adjustment Under the Gold Standard

3. 16.1 Introduction
To examine how a nation’s current account is affected by price changes
Assumption:
No autonomous financial flows
Exchange rate changes are utilized to correct a current account deficit

4. 16.2 Adjustment with Flexible Exchange Rates
The degree of depreciation needed to correct current account deficit depends on the elasticity of the demand and supply curve for foreign exchange

5. FIGURE 16-1 Balance-of-Payments Adjustments with Exchange Rate Changes.

6. FIGURE 16-2 Derivation of the U. S
FIGURE Derivation of the U.S. Demand andSupply Curves for Foreign Exchange.

7. 16.3 Effect of Exchange Rate Changes on Domestic Prices and the Terms of Trade
A devaluation or depreciation of a nation’s currency increases the domestic currency prices of the nation’s exports and import substitutes and is inflationary.
The terms of trade of the nation can rise, fall, or remain unchanged, depending on whether the price of expots rises by more than, less than, or the same percentages as the price of imports.

8. 16.4 Stability of Foreign Exchange Markets
FIGURE 16-3 Stable and Unstable Foreign Exchange Markets.

9. 16.5 Elasticities in the Real World
FIGURE 16-5 The J-Curve.

10. FIGURE 16-6 Effective Exchange Rate of the Dollar and U.S.
Current Account Balance,

11. 16.6 Adjustment Under the Gold Standard
FIGURE Gold Points and Gold Flows.