Economics Study Set 17

Business

Quiz 36 :

The International Monetary System: Order or Disorder

Quiz 36 :

The International Monetary System: Order or Disorder

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What items do you own or routinely consume that are produced abroad From what countries do these items come Suppose Americans decided to buy fewer of these things. How would that affect the exchange rates between the dollar and these currencies
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Exchange rate
Exchange rate refers to the amount of domestic currency required to purchase one unit of foreign currency. For example, 0.02 dollar is required to buy one Indian rupee; in this case, the exchange rate is $0.02: Rs1.
Consumption from abroad
The dress materials produced in India are consumed consistently. When American demand for dress material decreases, then American demand for Indian rupee, in the foreign exchange market, also decreases. This reduces the supply of American dollar in the foreign exchange market; and thereby increases the value of American dollar.
On the other hand, since Americans buy less amount of dress material the demand for Indian rupee falls; this reduces the value of Indian rupee. Hence, from an American's point of view, the exchange rate increases. Now, the same unit of American currency can buy more Indian rupee than earlier.

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Suppose each of the transactions listed in Test Yourself Question 2 was done by many Americans. Indicate how each would affect the international value of the dollar if exchange rates were floating. Reference Test Yourself Question 2 For each of the following transactions, indicate how it would affect the U.S. balance of payments if exchange rates were fixed: a. You spent the summer traveling in Europe. b. Your uncle in Canada sent you $20 as a birthday present. c. You bought a new Honda, made in Japan. d. You bought a new Honda, made in Ohio. e. You sold some stock you own on the Tokyo Stock Exchange.
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Balance of Payment
Balance of Payment refers to the total transaction of monetary services of the country with the rest of the world.
Floating Exchange Rate
Floating exchange rates are determined in the market by the free flow of demand and supply of currencies.
a. Favorable Balance of Payment
A summer trip to Europe increases the demand for euro. In a foreign exchange market, increase in the demand for euro against dollar increases the value of euro. This reduces the exchange rate of dollar against euro. The fall in dollar value increases U.S. exports and decreases U.S. imports. The increase in exports over imports improves the Balance of Payment.
b. Unfavorable Balance of Payment
A gift worth $20 from Canada increases the supply of Canadian dollar. The value of Canadian dollar in terms of American dollar increases. This increases the exchange rate of U.S. dollar against Canadian dollar. The fall in value of dollar increases U.S. exports and decreases U.S. imports. The increase in imports over exports reduces the Balance of Payment.
c. Favorable Balance of Payment
Purchase of new Honda from Japan increases the demand for Japanese yen against U.S. dollars. In foreign exchange market, increase in the demand for Yen against dollar increases the value of yen. This reduces the exchange rate of U.S. dollar against yen. The fall in value of dollar increases U.S. exports and decreases U.S. imports. The increase in exports over imports improves the Balance of Payment.
d. Favorable Balance of Payment
Purchase of new Honda from Ohio increases the demand for Ohio currency against U.S. dollars. In foreign exchange market, increase in the demand for Ohio currency against dollar increases the value of Ohio currency. This reduces the exchange rate of U.S. dollar against the currency of Ohio. The fall in dollar value increases U.S. exports and decreases U.S. imports. The increase in exports over imports improves the Balance of Payment.
e. Unfavorable Balance of Payment
The sale of stocks in the Tokyo Stock Exchange means the supply of Japanese shares and demand for U.S. dollar. This increases the value of dollar against yen, and thereby increases the exchange rate of U.S. dollar against Japanese yen. The fall in dollar value increases U.S. exports and decreases U.S. imports. The increase in imports over exports reduces the Balance of Payment.

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Explain why the members of the Bretton Woods conference in 1944 wanted to establish a system of fixed exchange rates. What flaw led to the ultimate breakdown of the system in 1971
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Bretton wood system
Under the gold standard fixed exchange rate system, supply of money depends on the gold reserve. Since the countries are unable to control the gold reserve, they can also not control the money supply. In the 1930s, the Second World War and the Great Depression caused failure of the gold standard fixed exchange rate system which collapsed the world trade.
To enable profitable world trade, Bretton wood fixed exchange rate system was established in 1944.
Causes for the failure of Bretton wood system in 1971
In the Bretton wood system, countries cannot change the exchange rate easily. A country can devalue its currency when it is in serious deficit in balance of payment. This will be implemented after a long period of time, which leads to reduction of the country's resources.

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Suppose you want to reserve a hotel room in London for the coming summer but are worried that the value of the pound may rise between now and then, making the room too expensive for your budget. Explain how a speculator could relieve you of this worry. (Don't actually try it-speculators deal only in very large sums!)
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For each of the following transactions, indicate how it would affect the U.S. balance of payments if exchange rates were fixed: a. You spent the summer traveling in Europe. b. Your uncle in Canada sent you $20 as a birthday present. c. You bought a new Honda, made in Japan. d. You bought a new Honda, made in Ohio. e. You sold some stock you own on the Tokyo Stock Exchange.
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How are the problems of a country faced with a balance of payments deficit similar to those posed by a government regulation that holds the price of milk above the equilibrium level (Hint: Think of each in terms of a supply-demand diagram.)
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In 2011, market forces raised the international value of the Japanese yen. Why do you think the government of Japan was unhappy about this currency appreciation (Hint: Japan was trying to recover from both a recession and a disastrous earthquake/tsunami at the time.) If they wanted to stop the yen's appreciation, what actions could the Bank of Japan (Japan's central bank) and the Federal Reserve have taken Why might the central banks have failed in this attempt
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We learned in this chapter that successful speculators buy a currency when demand is weak and sell it when demand is strong. Use supply and demand diagrams for two different periods (one with weak demand, the other with strong demand) to show why this activity will limit price fluctuations.
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Use supply and demand diagrams to analyze the effect of the following actions on the exchange rate between the dollar and the yen: a. Japan opens its domestic markets to more foreign competition. b. Investors come to believe that values on the Tokyo stock market will fall. c. The Federal Reserve cuts interest rates in the United States. d. The U.S. government, to help settle the problems of the Middle East, gives huge amounts of foreign aid to Israel and her Arab neighbors. e. The United States has a recession while Japan booms. f. Inflation in the United States exceeds that in Japan.
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Under the old gold standard, what do you think happened to world prices when a huge gold strike occurred in California in 1849 What do you think happened when the world went without any important new gold strikes for 20 years or so
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If the dollar appreciates relative to the euro, will the German camera you have wanted become more or less expensive What effect do you imagine this change will have on American demand for German cameras Does the American demand curve for euros, therefore, slope upward or downward Explain.
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During the first half of the 1980s, inflation in (West) Germany was consistently lower than that in the United States. What, then, does the purchasing-power parity theory predict should have happened to the exchange rate between the mark and the dollar between 1980 and 1985 (Look at Table 1 to see what actually happened.)
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