2. International Trade and Exchange Rates Outline Balance of payments accounting Exchange rates—how are they determined? Exchange rates and the price of imported and exported goods.

3. þBOP accounting is the recording of transactions between domestic and foreign economic agents. þAny transaction that results in a receipt of money by domestic agents from abroad is recorded as a credit in the BOP accounts. þAny transaction that entails the payment of money by domestic units to foreigners is recorded as a debit in the BOP accounts. þThe current account records foreign transactions involving merchandise and services. þThe capital account records foreign transactions involving financial assets and land. Balance of payments accounting

5. 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

6. 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 =

7. Exchange Rates are Determined by the Supply & Demand for Foreign Exchange Dollars per Euro Euros 0 Supply of euros Demand for euros E* 1.15

8. 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. Why do agents want to exchange dollars for euros ?

9. Dollars per Euro Euros 0 Supply of euros E* 1.15 Dollar Depreciates Against the Euro (and euro appreciates against the dollar) D1D1 D2D2 1.30

17. Currency Cross Rates New York Trading, July 25, 2003 Source: Wall Street Journal

19. 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?

20. 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

21. An appreciating dollar makes U.S.-made goods and services less price-competitive

22. 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

23. 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

24. 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

25. 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.