1.If a country runs a trade deficit, will the level of investment spending be greater than, less than, or equal to the level of domestic saving?
2.Currently, the nominal exchange rate is approximately 0.77 British pounds per dollar (or: about 1.30 dollars per pound) If the dollar appreciates against the pound, will a dollar buy more than or less than 0.77 pounds? Will a pound buy more or less than $1.30?
3.If the nominal exchange rate increases, what will happen to the real exchange rate, ceteris paribus? Will it increase, decrease, or remain the same?
4.If a currency appreciates, what do we expect to happen to net exports, ceteris paribus? Explain.
1.If a country runs a trade deficit, will the level of investment spending be greater than, less than, or equal to the level of domestic saving?
2.Currently, the nominal exchange rate is approximately 0.77 British pounds per dollar (or: about 1.30 dollars per pound) If the dollar appreciates against the pound, will a dollar buy more than or less than 0.77 pounds? Will a pound buy more or less than $1.30?
3.If the nominal exchange rate increases, what will happen to the real exchange rate, ceteris paribus? Will it increase, decrease, or remain the same?
4.If a currency appreciates, what do we expect to happen to net exports, ceteris paribus? Explain.
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Just as with the price of a good, the price, or exchange rate, of a currency is determined by supply and demand. However, rather than using a traditional supply and demand analysis as shown in Marthinsen, currency traders often consider whether foreign funds will flow into or out of a country as a result of a particular economic circumstance. If foreigners wish to make domestic purchases or investments, the foreign currency must first be exchanged for the domestic currency. Thus, foreign funds flowing into a country increase the demand for the domestic currency and it appreciates. Funds flowing out reverse this process leading to depreciation of the domestic currency. In the table, place an X to indicate whether each economic condition will cause foreign funds to flow in or out of the country and whether the domestic currency will appreciate or depreciate.
Domestic circumstance |
Funds flow in |
Funds flow out |
Currency appreciates |
Currency depreciates |
Real interest rates are higher than in other countries |
Ā | Ā | Ā | Ā |
Risk of civil war |
Ā | Ā | Ā | Ā |
Business taxes are raised above the world average |
Ā | Ā | Ā |
X |
Expected stock market returns are better than elsewhere |
Ā | Ā | Ā | Ā |
Inflation increases |
Ā | Ā | Ā | Ā |
A large deposit of rare earth minerals is discovered |
Ā | Ā | Ā | Ā |
Rapidly growing manufacturing sector imports more foreign raw materials |
Ā | Ā | Ā | Ā |
Just as with the price of a good, the price, or exchange rate, of a currency is determined by supply and demand. However, rather than using a traditional supply and demand analysis as shown in Marthinsen, currency traders often consider whether foreign funds will flow into or out of a country as a result of a particular economic circumstance. If foreigners wish to make domestic purchases or investments, foreign currency must first be exchanged for the domestic currency. Thus, foreign funds flowing into a country increase the demand for the domestic currency and it appreciates. Funds flowing out reverse this process leading to depreciation of the domestic currency. In the table, place an X to indicate whether each economic condition will cause foreign funds to flow in or out of the country and whether the domestic currency will appreciate or depreciate.
Domestic circumstance |
Funds flow in |
Funds flow out |
Currency appreciates |
Currency depreciates |
Real interest rates are higher than in other countries |
Ā | Ā | Ā | Ā |
Risk of civil war |
Ā | Ā | Ā | Ā |
Business taxes are raised above world average |
Ā | Ā | Ā | Ā |
Expected stock market returns are better than elsewhere |
Ā | Ā | Ā | Ā |
Inflation increases |
Ā | Ā | Ā | Ā |
A large deposit of rare earth minerals is discovered |
Ā | Ā | Ā | Ā |
Rapidly growing manufacturing sector imports more foreign raw materials |
Ā | Ā | Ā | Ā |
World commodity prices (such as oil or grain) fall in a country that is a major commodity exporter |
Ā | Ā | Ā | Ā |
GDP increases |
Ā | Ā | Ā | Ā |
PI falls |
Ā | Ā | Ā | Ā |