Part- 4 Chapter- 19

Aplia Homework: The International Monetary System: Order or Disorder?

1. Pricing foreign goods

The nominal exchange rate is the price of one currency in terms of another currency. A nominal exchange rate specifies how many units of one country's currency are needed to buy one unit of another country's currency.

Suppose the following table forecasts nominal exchange rate data for March 16, 2023, in terms of U.S. dollars per unit of foreign currency. Use the information in the table to answer the questions that follow.

Suppose that on March 16, 2023, an antique woven rug handmade in Japan is priced at 536,660 JPY. The approximate U.S. dollar price of the rug would be ________.

If the nominal exchange rate for the U.S. dollar–Japanese yen rises from $0.008538 to $0.0098187 per Japanese yen, the U.S. dollar __________ in value, or _________, relative to the Japanese yen.

2. The foreign exchange market

The following question focuses on the exchange rate between Mexican pesos and U.S. dollars, defined as the number of Mexican pesos you must pay to obtain one dollar.

Suppose that preferences for goods made in the United States change in Mexico, causing Mexican consumers to purchase more goods and services made in the United States.

Shift the appropriate curve or curves on the following graph to illustrate how this change affects the market for dollars.

Note: Select and drag one or both of the curves to the desired position. Curves will snap into position, so if you try to move a curve and it snaps back to its original position, just drag it a little farther.

A change in preferences that causes Mexican consumers to buy more U.S.-made goods and services will cause the Mexican peso to _________ relative to the dollar.

3. Changes in the foreign-exchange market

The following questions focus on the exchange rate between the Malaysian ringgit and the Danish krone. Assume the exchange rate is flexible. The exchange rate is defined as the number of ringgit you must pay for one krone.

Suppose a recession in Malaysia causes Malaysian incomes to decrease, while incomes in Denmark remain the same.

Assuming asset returns in the two countries do not change as a result of their differing growth rates, shift the appropriate curve or curves on the following graph to illustrate how this affects the market for Danish kroner.

Note: Select and drag one or both of the curves to the desired position. Curves will snap into position, so if you try to move a curve and it snaps back to its original position, just drag it a little farther.

The decrease in Malaysian incomes causes the Danish krone to __________ relative to the Malaysian ringgit and causes the Malaysian ringgit to __________ relative to the Danish krone.

Suppose the price level in Denmark rises by 5%, while the price level in Malaysia remains the same. That is, the inflation rate in Denmark is higher than that in Malaysia.

Drag the appropriate curve or curves on the following graph to illustrate how this affects the market for Danish kroner.

Suppose the real interest rates in Malaysia and Denmark are initially the same. Then the real interest rate in Denmark rises, while the real interest rate in Malaysia remains the same. This will cause the supply of kroner to __________ and the demand for kroner to __________, which causes the Malaysian ringgit to __________ relative to the Danish krone.

4. Purchasing power parity

Using data from The Economist's Big Mac Index for 2011, the following table shows the local currency price of a Big Mac in several countries as well as the actual exchange rate between each country and the United States. At the time of the data collection, a Big Mac would have cost you $4.07 in the United States and GBP 2.39 in the United Kingdom. The actual exchange rate between the British pound and the U.S. dollar was $1.63 per pound. The dollar price of a Big Mac purchased in the United Kingdom was, therefore, computed as follows:

For the price you paid for a Big Mac in the United States, you could have purchased a Big Mac in the United Kingdom and had some change left over for fries!

Complete the final column of the table by computing the dollar price of a Big Mac for the countries where this amount is not given.

Note: Round your answers to the nearest cent.

Purchasing power parity (PPP) theory states that exchange rates adjust to equalize the prices of goods in any two countries. For the dollar price of a Big Mac in the United States and the United Kingdom to be identical, a U.S. citizen would need to be able to convert $4.07 into GBP 2.39 GBP exactly. To find the exchange rate at which hamburger purchasing power is the same in both countries, divide the price in the United States by the price in the United Kingdom:

The exchange rate that would have equalized the dollar price of a Big Mac in the United States and the Eurozone (that is, the PPP exchange rate for Big Macs) is __________. This change would mean that the dollar had __________ against the euro.

If Big Macs were a durable good that could be costlessly transported between countries, which of the following would present an arbitrage opportunity (that is, an opportunity to buy a good at a low price in one market and sell it at a higher price in another market and pocket the difference)? Check all that apply.

            Exporting Big Macs from India to China

            Exporting Big Macs from the United States to the Eurozone

            Exporting Big Macs from Poland to China

5. Fixed exchange rates

Consider the exchange rate between the Saudi riyal and the euro. Suppose the Saudi government and the Eurozone governments agree to fix the exchange rate (ER) at 1 riyal per euro, as shown by the grey line on the following graph.

Refer to the following graph when answering the questions that follow.

At the official exchange rate of 1 riyal per euro, the euro is ________, and the Saudi riyal is ________, which means that Saudis pay ________ for European exports than they would with a free-floating exchange rate.

At the official riyal price of euros, there is a _________ of euros in the foreign exchange market.

Suppose the governments in the Eurozone and Saudi Arabia agree to change the official exchange rate from 1 riyal per euro to 2 riyal per euro. The action represents a __________ of the euro and a ___________ of the riyal.

6. Balance of payments and the foreign exchange market

The following graph shows the market for euros, which is initially in equilibrium. Suppose an economic expansion in the United States leads to an increase in the incomes of American households, causing imports from Europe to rise.

On the graph, illustrate the effect of an economic expansion on the market for euros by shifting the appropriate curve or curves.

Note: Select and drag one or both of the curves to the desired position. Curves will snap into position, so if you try to move a curve and it snaps back to its original position, just drag it a little farther.

On the previous graph, use the purple point (diamond symbol) to indicate the new equilibrium exchange rate and quantity under a system of flexible exchange rates.

Under a system of flexible exchange rates, the dollar will __________ until the foreign exchange market reaches an equilibrium exchange rate of __________.

Now suppose that the United States expends a portion of its euro reserves to maintain the initial equilibrium exchange rate of $2 per euro.

On the previous graph, use a grey point (star symbol) to indicate the new equilibrium under a system of fixed exchange rates.

Under system of fixed exchange rates, which of the following policies could the U.S. government use to prevent the change in demand for euros from driving the exchange rate to the new equilibrium?  Check all that apply.

            Reduce income taxes in the United States

            Sell U.S. euro reserves in the foreign exchange market

            Lower interest rates by way of monetary policy

7. Gold standard

Between 1879 and 1934, the world's major nations adhered to the gold standard. Under the gold standard, a country maintained a fixed relationship between its stock of gold and its money supply. Suppose that Great Britain defined a British pound as 30 grains of gold, and the United States defined $1 as 60 grains of gold.

Under the gold standard, a British pound would have been worth _______ U.S. dollars.

Suppose the fixed exchange rate is $0.50 per pound. Suppose that an economic expansion in the United States leads to an increase in imports from Great Britain.

On the following graph, shift the relevant curve or curves to illustrate the described changes. Then use the black points (plus symbol) to indicate the imbalance.

An economic expansion in the United States leads to an increase in imports from Great Britain ________ the demand for British pounds and leading to a _________ million pounds _________ in the balance-of-payments.

Under the gold standard, the fixed exchange rate is maintained in the face of the balance-of-payments imbalance shown on the preceding graph because gold must flow from _______ to ________.

8. Why exchange rates matter

Suppose that you go on vacation to Canada every summer. Last year, the hotel room where you stayed cost C$120 per night, and it costs the same this year. The exchange rate was 1.1 US$/C$ last year, and it is 0.98 US$/C$ this year. This means you will pay _________ per night this year than you paid last year.

The U.S. dollar–Canadian dollar exchange rate is essentially the price of a Canadian dollar in terms of U.S. dollars. When this price falls, the Canadian dollar is said to depreciate against the U.S. dollar. Thus, from your analysis, you can conclude that when the Canadian dollar depreciates against the U.S. dollar, Canadian goods and services become ______ expensive for Americans.

DeutschAuto is a German automaker that pays most of its production costs in euros. Suppose that in 2003, DeutschAuto's cost of producing a car was €26,500 and that the company sold a car in the United States for $42,000. Further, suppose that the dollar–euro exchange rate rose from 1$/€ in 2003 to 1.57$/€ in 2008. DeutschAuto's euro cost of production did not change, and the company continued to charge $42,000 for its cars in the United States, as DeutschAuto believes this is its profit-maximizing price. Examine how the rise in the dollar–euro exchange rate affects DeutschAuto's profits from sales in the United States. (Hint: Ignore transportation costs.)

In 2003, DeutschAuto's revenue from sales in the United States was _________ per car. Given the cost of production, this means that DeutschAuto's profit was _________ per car.

In 2008, DeutschAuto's revenue from sales in the United States was __________ per car. Given the cost of production, this means that DeutschAuto's profit was _________ per car.

The dollar–euro exchange rate is essentially the price of one euro in terms of dollars. When this price rises, the euro is said to appreciate against the dollar. Thus, from your analysis, you can conclude that when the euro appreciates against the dollar, it becomes __________ for European companies to profit from exporting their products to the United States.

Suppose that the Japanese government and private investors hold $750 billion in U.S. Treasury securities. When the Japanese yen–U.S. dollar exchange rate is 99 ¥/$, these assets are worth _________. If the dollar appreciates to 115 ¥/$, the U.S. Treasury securities held in Japan will be worth __________.

The yen–dollar exchange rate is essentially the price of one dollar in terms of yen. When this price rises, the dollar is said to appreciate against the yen. Thus, from your analysis, you can conclude that when the dollar appreciates against the yen, holders of U.S. Treasury securities in Japan experience _________ ________ in their wealth.