Deck 22: Globalization and International Impacts on the Economy

Question 1

Every nation's balance of payments equals zero. Therefore, is each nation on an equal footing in international trade and finance with every other nation? Explain your answer.

Answer 1

Balance of Payments
It is a periodic (usually annual) statement of the money value of all transactions between residents of one country and the residents of all other countries. Balance of payments accounts record both debits and credits. A debit is indicated by a minus (-) sign, and a credit is indicated by a plus (+) sign.
Debit
In the balance of payments, any transaction that supplies the country's currency in the foreign exchange market
Credit
In the balance of payments, any transaction that creates a demand for the country's currency in the foreign exchange market
The balance of payments is the summary statistic for :
• Exports of goods and services
• Imports of goods and services
• Net unilateral transfers abroad
• Outflow of country`s capital.
• Inflow of foreign capital
• Increase in country`s official reserve assets.
• Increase in foreign official assets in the country.
• Statistical discrepancy
There is a tendency to think that the balance of payments can be in deficit or surplus, but it is neither. The balance of payments always equals zero because the three accounts that comprise the balance of payments, taken together, plus the statistical discrepancy, include all of the sources and all of the uses of dollars in international transactions. In addition, every dollar used must have a source, adding the sources (+) to the uses (-) necessarily gives us zero.
This way, whatever the export, import, capital and current account status, official foreign reserve, foreign assets and statistical discrepancy a particular country posses, they all have their Balance of payments equal to Zero and hence it is correct say that each nation on an equal footing in international trade and finance with every other nation

Question 2

Suppose your objective is to predict whether the euro (the currency of the European Union) and the U.S. dollar will appreciate or depreciate on the foreign exchange market in the next two months. What information would you need to help make your prediction? Specifically, how would this information help you predict the direction of the foreign exchange value of the euro and dollar? Next, explain how a person who could accurately predict exchange rates could become extremely rich in a short time.

Answer 2

Factors that helps to predict the movement (appreciation/ depreciation) of currency (U.S Dollar) of a country (America):
1. Relative Inflation rates
2. Relative Interest rates
3. Relative economic growth rates
4. Political risk
5. Expectations
We take Mexico to show the movement of American currency (U.S dollar) in comparison with Mexican currency (Peso) in various scenarios of foreign trade among them.
If U.S. residents experience a growth in income but Mexican residents do not, U.S. demand for Mexican goods will increase, and with it, the demand for pesos. As a result, the exchange rate will change; the dollar price of pesos will rise. The dollar depreciates, and the peso appreciates.
Inflation, Exchange Rates, and Movement of currency
If the price level in the United States increases by 10 percent while the price level in Mexico remains constant, then the U.S. demand for Mexican goods (and therefore pesos) will increase and the supply of pesos will decrease. As a result, the exchange rate will change; the dollar price of pesos will rise.
The dollar depreciates, and the peso appreciates. PPP theory predicts that the dollar will depreciate in the foreign exchange market until the original price (in pesos) of American goods to Mexican customers is restored. In this example, this requires the dollar to depreciate 10 percent (3) as shown in the U.S. balance of payments, more than goods flow between countries. Financial capital also moves between countries. The flow of financial capital depends on different countries' real interest rates -interest rates adjusted for inflation.
To illustrate, suppose initially that the real interest rate is 3 percent in both the United States and Mexico. Then the real interest rate in the United States increases to 4.5 percent. As a result, Mexicans will want to purchase financial assets in the United States that pay a higher real interest rate than do financial assets in Mexico. The Mexican demand for dollars will increase, and therefore Mexicans will supply more pesos. As the supply of pesos increases on the foreign exchange market, the exchange rate (the dollar price per peso) will change; fewer dollars will be needed to buy pesos. In short, the dollar will appreciate, and the peso will depreciate.
The same factors are common for the behavior of U.S. dollar in the same scenario with Euro too.
Watching these symptoms closely can make anyone expert in reading and understanding the movement of currency and hence proper strategies can give great outcomes. If a person is well aware of the movement of currency, one can make become rich as he can be in a win-win situation. If the one is belongs to the exchange market he can make more of purchases in depreciated currency and can sell in appreciated currency.

Question 3

Suppose the price of a Big Mac always rises by the percentage rise in the price level of the country in which it is sold. According to the purchasing power parity (PPP) theory, we would expect the price of a Big Mac to be the same everywhere in the world. Why?

Answer 3

The purchasing power parity theory in economics predicts that the exchange rate between two currencies will adjust so that, in the end, $1 buys the same amount of a given good in all the places around the world.
Now, if you consider a good that is sold all over the world: McDonald's Big Mac. Suppose the exchange rate between the dollar and the yen is $1 = ¥100 and the price of a Big Mac in New York City is $3 and ¥400 in Tokyo. Given the exchange rate, a Big Mac is not selling for the same price in the two cities. In New York, it is $3, but in Tokyo, it is $4 (the price in Tokyo is ¥400, and $1 = ¥100). Stated differently, in New York, $1 buys one-third of a Big Mac, but in Tokyo, $1 buys only one-fourth of a Big Mac. However, Big Macs won't be shipped from New York to Tokyo to fetch the higher price. Instead, the exchange rate is likely to adjust in such a way that the price of a Big Mac is the same in both cities
Now, as you are required to know about the exchange rate between the dollar and yen before the Big Mac is the same dollar price in New York and Tokyo. The answer is the first one: $1 = ¥133.33. At this exchange rate, a Big Mac in New York is $3, and a Big Mac in Tokyo that is ¥400 is $3 (once we have computed its price in dollars). At the exchange rate of $1 = ¥133.33, ¥1 equals $0.0075, and $0.0075 times ¥400 is $3.
Thus, if the exchange rate is initially $1 = ¥100 when a Big Mac is $3 in New York and ¥400 in Tokyo, it will change to become $1 = ¥133.33. That is, the dollar will soon appreciate relative to the yen.

Question 4

If everyone in the world spoke the same language, would the world be closer to or further from being an optimal currency area? Explain.

Question 5

Suppose the United States and Japan have a flexible exchange rate system. Explain whether each of the following events will lead to an appreciation or depreciation in the U.S. dollar and Japanese yen.
a. U.S. real interest rates rise above Japanese real interest rates.
b. The Japanese inflation rate rises relative to the U.S. inflation rate.
c. Japan imposes a quota on imports of American radios.

Question 6

Give an example of how a change in the exchange rate alters the relative price of domestic goods in terms of foreign goods.

Question 7

If $1 equals ¥0.0093, what does ¥1 equal?

Question 8

Suppose the media report that the United States has a deficit in its current account. What does this imply about the U.S. capital account balance and official reserve account balance?

Question 9

If $1 equals 7.7 krone (Danish), what does 1 krone equal?

Question 10

Suppose Canada has a merchandise trade deficit and Mexico has a merchandise trade surplus. The two countries have a flexible exchange rate system; so the Mexican peso appreciates and the Canadian dollar depreciates. However, soon after the depredation of the Canadian dollar, Canada's trade deficit grows instead of shrinks. Why might this occur?

Question 11

If $1 equals 31 rubles, what does 1 ruble equal?

Question 12

What are the strong and weak points of the flexible exchange rate system? What are the strong and weak points of the fixed exchange rate system?

Question 13

If the current account is -$45 billion, the capital account is +$55 billion, and the official reserve balance is -$1 billion, what does the statistical discrepancy equal?

Question 14

Individuals do not keep a written account of their balance of trade with other individuals. For example, John doesn't keep an account of how much he sells to Alice and how much he buys from her. In addition, neither cities nor any of the 50 states calculate their balance of trade with all other cities and states. However, nations do calculate their merchandise trade balance with other nations. If nations do so, should individuals, cities, and states do so? Why or why not?

Question 15

Why does the balance of payments always equal zero?