International Trade and Exchage Rates

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1. How do changes in interest rates, inflation, productivity, and income affect exchange rates?
Higher interest rates result in a positive capital inflow, as foreigners purchase more U.S. assets than Americans purchase of foreign assets. The dollar appreciates making American goods more expensive to foreigners, and foreign goods cheaper to Americans, and a trade deficit results. Inflation causes interest rates to increase further, which aggravates trade deficits. Productivity s a source of economic growth. As workers produce more they can be compensated with higher wages. This results in more income which workers will spend on goods and services. Economic growth results in a higher interest rate, which causes an increase in the exchange rate.

2. Is a strong U.S. dollar always good for the U.S. economy? Why or why not?
A strong dollar is a sign that foreign countries see the US economy as a good investment, but it does nothing to help the domestic economy. It is harmful, because it makes US goods and services relatively more expensive. As the exchange rate increases, it become more difficult for foreigners to buy US goods with their currency. This results in a decline in our exports. We buy relatively more imports, however since our currency is strong. Thus our trade deficit increases until the exchange rate declines.

3. What parties benefit from the imposition of tariffs and quotas? What parties lose from the imposition of tariffs and quotas?

Tariffs are a form of taxation which benefits domestic manufacturers at the expense of the consumer. They pay a higher price than would have been the case had no duty been imposed on the importer. Another consumer group is the one which buys an American product at a high price which is protected by the tariff. Were there no tariff, the domestic firms would either be forced to lower their prices or shift to some line of production in which they could compete successfully. Then there is the non-consumer group which would have entered the market had the lower prices been in effect; their form of the "tax" is simply the inability to enjoy the use of products which might have been available to them had the State not intervened in international trade. A quota benefits domestic producers in the same way a tariff does, but the additional money expended on foreign goods goes to the foreign producers, not the domestic ...