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International Trade and Exchage Rates

Week 4: Discussion Questions
1. How do changes in interest rates, inflation, productivity, and income affect exchange rates?
2. Is a strong U.S. dollar always good for the U.S. economy? Why or why not?
3. What parties benefit from the imposition of tariffs and quotas? What parties lose from the imposition of tariffs and quotas?
4. What are the positives and negatives of protectionist trade policies on the part of the federal government? Which policy do you think is best right now?
5. What is the impact of a trade surplus on the exchange rate value of the dollar? Explain.
6. What is the impact of a trade deficit on the exchange rate value of the dollar? Explain.
7. How is international trade related to the standard of living of the United States as
opposed to a small industrial nation or of a developing nation? Note: Be sure to include
in your treatment the impact of the aggregate price level.
8. How might trade agreements have a positive or negative impact on your firm? If your firm or organization is not impacted, do not answer this question.
9. In the 1990s, Japan's economic recession was much in the news. What would you suspect was happening to its trade balance during this time? What policies would you guess other countries (such as those in the Group of Eight) were pressuring Japan to implement?
10. One of the basic laws of economics is the law of one price. It says that given
certain assumptions one would expect that if free trade is allowed, the prices of
goods in multiple countries should converge. This law underlies purchasing
power parity.
Can you list what three of those assumptions likely are?
b. Should the law of one price hold for labor also? Why or why not?
c. Should it hold for capital more so or less so than for labor? Why or why not?
11. A country eliminates all tariffs. Would you expect that the value of its currency to rise or fall? Explain your answer.

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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 ...

Solution Summary

Determination of exchange rates; protectionism; and how recessions affect balance of trade

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