Topic 12

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  • Market Structure Past Paper Questions
  • Market Structure Past Paper Questions
  • Topic 12

    1. 1. Exchange Rates Chapter #17 EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    2. 2. Floating Exchange Rate <ul><li>Under the floating exchange rate system, the exchange rate between the domestic currency and the foreign currency is determined by the demand and supply in the foreign exchange market. </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    3. 3. Floating Exchange Rate in Jamaica EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) S S D Jam$/US$ E Q E Quantity of US dollar traded D Jam$40 = US$1
    4. 4. Floating Exchange Rate <ul><li>All outflows in the balance of payments create demand for foreign currency . </li></ul><ul><li>The supply of foreign currency arises from all inflows of foreign exchange in the balance of payments . </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    5. 5. An increase in demand for foreign exchange in Jamaica EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) S S D 1 D 1 D 2 D 2 E 1 E 2 Q 1 Q 2 Jam$/US$ Jam$40 = US$1 Jam$50 = US$1 Quantity of US dollar traded
    6. 6. A decrease in demand for foreign exchange in Jamaica EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) S S D 1 D 1 D 2 D 2 E 2 E 1 Q 1 Q 2 Jam$/US$ Jam$40 = US$1 Jam$30 = US$1 Quantity of US dollar traded
    7. 7. A decrease in supply of foreign exchange in Jamaica EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) D D S 1 S 1 S 2 S 2 E 1 E 2 Q 1 Q 2 Q US$ Jam$/US$ Jam$40 = US$1 Jam$50 = US$1
    8. 8. An Increase in supply of foreign exchange in Jamaica EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) D D S 1 S 1 S 2 S 2 E 2 E 1 Q US$ Q 1 Q 2 Jam$40 = US$1 Jam$30 = US$1 Jam$/US$
    9. 9. The Fixed Exchange Rate <ul><li>Under the fixed exchange rate system, the exchange rate is set by the Government </li></ul><ul><li>In Barbados for instance, a fixed exchange rate is adopted with the United States dollar where Bds$2 = US$1. </li></ul><ul><li>If the official rate coincides with the equilibrium rate in the foreign exchange market, then there is no need for government intervention. </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    10. 10. The Fixed Exchange Rate EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) D D S S Official Rate Bds$2 = US$1 Q US$
    11. 11. Fixed Exchange Rate and a Surplus in the Foreign Exchange Market D 1 D 1 S S Official Rate E 1 Bds$2 = US$1 Bds$1 = US$1 Bds$/US$ Q US$ Q S Q D Surplus EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    12. 12. Increase in Money Supply under a Fixed Exchange Rate D 1 D 1 S S D 2 D 2 Official Rate E 1 E 2 Bds$2 = US$1 Bds$1 = US$1 Bds$/US$ Q US$ Q D = Q S Jamaican Central Bank must purchase the surplus foreign exchange from the market . This causes an increase in the money Supply EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    13. 13. Fixed Exchange Rate and a Shortage in the Foreign Exchange Market EDWARD BAHAW - Economic Principles and Their Application to Business (ABE) D D S 1 Official Rate Q US$ Bds$2 = US$1 Bds$/US$ Bds$3 = US$1 S 1 E 1 Q S Q D Shortage
    14. 14. Decrease in Money Supply under a Fixed Exchange Rate D D S 1 Official Rate Q US$ Bds$2 = US$1 Bds$/US$ Bds$3 = US$1 S 1 E 1 S 2 S 2 E 2 Q D = Q S Jamaican Central Bank must sell foreign exchange to the market . This causes a decrease in the money Supply EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    15. 15. Advantages of a Floating Exchange Rate System <ul><li>The exchange rate would adjust to attain equality between exports and imports. </li></ul><ul><li>No need to manipulate reserves </li></ul><ul><li>Control over the money supply </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    16. 16. Disadvantages of a Floating Exchange Rate System <ul><li>Speculation </li></ul><ul><li>Uncertainty </li></ul><ul><li>Inflation </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    17. 17. Advantages of a Fixed Exchange Rate System <ul><li>Stability </li></ul><ul><li>Avoid speculation </li></ul><ul><li>Prevents inflation </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    18. 18. Disadvantages of a Fixed Exchange Rate System <ul><li>The loss of monetary policy </li></ul><ul><li>The need for a large pool of reserves </li></ul><ul><li>Current account imbalances </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    19. 19. Expansionary Fiscal Policy and a Floating Exchange Rate <ul><li>Expansionary fiscal policy </li></ul><ul><li>Decrease in taxes, increase in government spending </li></ul><ul><li>Income increases </li></ul><ul><li>Imports increase </li></ul><ul><li>Exchange rate adjusts </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    20. 20. Contractionary Fiscal Policy and a Floating Exchange Rate <ul><li>Contractionary fiscal policy </li></ul><ul><li>Increase in taxes, decrease in government spending </li></ul><ul><li>Income declines </li></ul><ul><li>Imports decreases </li></ul><ul><li>Exchange rate adjusts </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    21. 21. Expansionary Monetary Policy and a Floating Exchange Rate <ul><li>Expansionary monetary policy </li></ul><ul><li>Interest rates decline </li></ul><ul><li>Income increases </li></ul><ul><li>Imports increases </li></ul><ul><li>Exchange rate adjusts </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    22. 22. Contractionary Monetary Policy and a Floating Exchange Rate <ul><li>Contractionary monetary policy </li></ul><ul><li>Interest rates rise </li></ul><ul><li>Income declines </li></ul><ul><li>Imports decreases </li></ul><ul><li>Exchange rate adjusts </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    23. 23. Contractionary Fiscal Policy and a Fixed Exchange Rate <ul><li>Contractionary fiscal policy </li></ul><ul><li>Increase in taxes, decrease in government spending </li></ul><ul><li>Income increases </li></ul><ul><li>Imports rise </li></ul><ul><li>Shortage created in foreign exchange market </li></ul><ul><li>Money supply decreases </li></ul><ul><li>Interest rate increases </li></ul><ul><li>Income decreases </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    24. 24. Contractionary Monetary Policy and a Fixed Exchange Rate <ul><li>Contractionary monetary policy </li></ul><ul><li>Interest rate increases </li></ul><ul><li>Income declines </li></ul><ul><li>Imports decreases </li></ul><ul><li>Surplus of foreign exchange in the market </li></ul><ul><li>Money supply increases </li></ul><ul><li>Interest rate falls </li></ul><ul><li>Income increases </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    25. 25. Expansionary Fiscal Policy and a Fixed Exchange Rate <ul><li>Expansionary fiscal policy </li></ul><ul><li>Decrease in taxes, increase in government spending </li></ul><ul><li>Income increase </li></ul><ul><li>Imports rise </li></ul><ul><li>Shortage created in foreign exchange market </li></ul><ul><li>Money supply decreases </li></ul><ul><li>Interest rate rise </li></ul><ul><li>Income decreases </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    26. 26. Contractionary Monetary Policy and a Fixed Exchange Rate <ul><li>Contractionary monetary policy </li></ul><ul><li>Interest rate increases </li></ul><ul><li>Income declines </li></ul><ul><li>Imports decreases </li></ul><ul><li>Surplus of foreign exchange in the market </li></ul><ul><li>Money supply increases </li></ul><ul><li>Interest rate falls </li></ul><ul><li>Income increases </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)
    27. 27. Dec 2008 <ul><li>Q6 (a) Discuss the basic differences between fixed and floating exchange rates. (5 marks) </li></ul><ul><li>(b) Discuss the advantages and disadvantages of fixed and floating exchange rate systems for: </li></ul><ul><li>(i) a business which engages in international trade; (10 marks) </li></ul><ul><li>(ii) a government concerned with controlling inflation using fiscal or monetary policy. (10 marks) (Total 25 marks) </li></ul>EDWARD BAHAW - Economic Principles and Their Application to Business (ABE)

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