Unit 5: International Trade and FOREX

Name: ______Date: ______Period: ______

Macroeconomics

Unit 5: International Trade and FOREX

Chapter 35: International Trade

Chapter 36: Exchange Rates, the Balance of Payments and Trade Deficits

1. Comparative Advantage: Figures represent the amount that can be produced with a fixed amount of inputs.

a.  Which country has the absolute advantage in coffee? Which country has the absolute advantage in sugarcane? Explain how you arrive at that answer?

b.  What is Jamaica’s opportunity cost for producing one unit of coffee? What is Puerto Rico’s opportunity cost for producing one unit of sugarcane? Show your work.

c.  Which country has the comparative advantage in coffee? Which country has the comparative advantage in sugarcane? Show how you arrive at that answer?

d.  Should these countries trade? If so, explain their terms of trade?

2.  Balance of Payments

a.  Explain whether each of the following creates a demand for or a supply of European Euros in foreign exchange markets:

i. A U.S. airline firm purchases several Airbus planes assembled in France.

ii. A German automobile firm decides to build an assembly plant in South Carolina.

iii. A U.S. college student decides to spend a year studying at the Sorbonne in Paris.

iv. A U.S. government bond held by a Spanish citizen matures, and the loan amount is paid back to that person.

b.  Smithland’s balance-of-payments data for 2006 are shown below in billions. What are the:

i. Balance of goods

ii. Balance of goods and services

iii. Balance on current account

iv. Balance on the capital and financial account

v. Suppose that Smithland needed to deposit $10 billion of official reserves into the capital and financial account to balance it against the current account. Does Smithland have a balance-of-payments deficit or surplus? Explain.

3. Exchange Rates

a. Explain the difference between flexible exchange rates and fixed exchange rates?

b. Use a supply and demand graph of US dollars to show your understanding of what causes the dollar to appreciate and depreciate?

c. Describe the determinants of exchange rates.

4. Assume that South Korea and Canada are trading partners. Complete the following regarding the Canadian dollar and the South Korean currency, the won.

a. Draw a correctly labeled graph for the foreign exchange market for the Canadian dollar.

b. Explain how each of the following will affect the demand for the Canadian dollar.

i.  The inflation rate in Canada is higher than the inflation rate in South Korea.

ii. Real interest rates in Canada fall relative to real interest rates in South Korea.

c. Given your answer in part (b) (ii), indicate how the value of the Canadian dollar is affected.

d. As a result of the currency change in part (c), what will happen to Canadian exports to South Korea? Explain.

5. Assume the real interest rate in both the United States and European Union equals 4.5 percent.

a. Assume the real interest rate in the United States falls to 3.75 percent.

i. How will the flow of financial capital between the United States and the European Union be affected? Explain.

ii. Using a correctly labeled graph of the foreign exchange market for the euro, show how the value of the euro would change relative to the United States dollar in a flexible exchange rate system.

b. Explain how the change in value of the euro in part (a) (ii) would affect the European Union’s net exports.