Major Processes in Economics - Essay Example

? Due: ECONOMICS ESSAY CHAPTER 3 a) The price of coffee in Cote d’Ivoire 30*5000=166.6667 CFA francs per Pound.(b) The relative price of coffee in Cote d’Ivoire versus Vietnam Relative prices. Cote d’Ivoire/ Vietnam 160/5000=0.032 Vietnam/Cote d’Ivoire 5000/160=31.25 Coffee traders will buy prefer buying coffee in Cote d’Ivoire due to the low relative price and sell in Vietnam due to the high relative price. The price of coffee in Cote d’Ivoire will tend to be high locally while in Vietnam, the prices will be low as much will be imported. 2. (a) The law of one price will hold in the case of rice traded freely in U.S and Canada. For the law of one price to hold, the market should be free from any trade barrier. The relative price is less than one. (1/1.04=0.9615) (b) The law of one price will not hold in the case of sugar traded in Mexico and the U.S. This is due to the imposition of quota by the U.S government o imports. The relative price is less than one. (1/93.05=0.0107) (c) The law of one price will hold in the case of Big Mac sold in the U.S and Japan. This is due to the fact that the good is identical. The relative price is less than one. (1/12.93=0.0773) (d) The law of one price will not hold in the case of haircuts in U.S and the U.K due to the fact that there is no good being traded internationally. The relative price is greater than one. (1/0.65=1.5385) Country(Currency) measured in FX units) Per $, E Fx/$ Price of market Basket ( in Fx) Price of U.S Basket in Fx (pUS timesEfx/$) Real Exchange Rate,qcountry/us Does ppp hold, (Yes/No) Is Fx currency overvalued or undervalued? (U or O) Is Fx currency expected to have real apprerciation or Depreciation Brazil (real) 2.1893 520 415.967 0.4568 Yes U A India ( rupee) 46.6672 12,000 8866.768 0.0214 Yes U A Mexico (peso) 11.0131 1,800 2092.489 0.0908 Yes U A South Africa (rand) 6.9294 800 1316.586 0.1443 Yes U A Zimbabwe (Z$) 101,347 4,000,000 19,255,930 9.8671 No O D 4. Country Exchange rate Per U.S$(Jan 2010) PPP implied Exchange rate(July 2009) Change in Exchange rate with PPP implied rates Actual Exchange rate(July 2009) Change in Exchange rate with Actual rates Australia(A$) 0.90 2.25 -1.35 2.00 -1.1 Brazil(real) 1.74 0.64 1.1 0.62 1.12 Canada(C$) 1.04 1.09 -0.05 1.16 -0.02 Denmark(Krone) 5.17 8.26 -3.09 5.34 -0.17 Eurozone(euro) 0.69 0.93 -0.24 0.72 -0.03 Japan(Yen) 93.05 89.6 3.45 92.6 0.45 Mexico(peso) 12.92 9.24 3.68 13.8 -0.88 Sweden(Krone) 7.14 10.9 -3.76 7.90 -0.76 The change in exchange rates is not consisted with the PPP implied exchange rates. The failure of the Big Mac Index to correctly predict changes in the nominal exchange rate between July 2009 and Jan 2010 can be attributed to the fact that, the demand for the big Macs products is not uniform in all the countries. The price of the big Mac varies significantly from country to country due to the difference in commercial costs such as advertising and transportation costs. 7. (a) Korea Japan Rate of Inflation Rate of Inflation 12/6=2% 2/1=2% (b) The expected rate of depreciation will be, (2.5-2.0)/2.0=0.25% (c) New inflation rate in Korea 15/6=2.5% (d) The increase in money supply will lead to a decrease in the price level and an increase in the exchange rate. (e) Suppose the bank of Korea want to maintain an exchange rate peg with the Japanese Yen, they will have to choose a money growth rate of 14% to keep the value of the won fixed relative to the Yen (f) In order for Korea to implement a policy that will ensure appreciation of the won against Japanese Yen, they need to set a growth rate between 12% and 16%. This is because the range will allow for a steady growth with low rate of inflation. 11. (a) Importance of having a nominal anchor. Nominal anchor such as exchange rate is that it provides a simple approach that can easily be understood by all members of the public. It also provides a quick means of curbing high inflation rate. A major drawback according to Obstfeld and Rogoff, (1996) is that it leads to loss in the independent and reliability of the monetary policy. They can also lead to fragility in the financial sector. Fear of resurgence is also eminent with the use of nominal anchors in taming inflation. (b) Rate of money supply in the economy. 3*4=12% The money supply growth rate that will allow the inflation rate target to be met. 3*2.5=7.5% c) The lira will depreciate relative to the dollar. 2%-2.5%=-0.5 (d) Current nominal interest rate using the Fisher equation. 1.5%+4.0%=5.5% The nominal interest rate that will allow for the achievement of the expected inflation rate. 1.5%+2.5%=4.0% CHAPTER 4 2. (a) A permanent increase in the supply of the rupee, will lead to increase in the value of the rupee against the dollar. This will be best witnessed in the short- run. However in the long-run, a further increase in the supply of the dollar will not lead to any further decrease in the exchange rate. (b) The exchange rate will decrease with time as the price level rises. However the decrease will reach a point in which it will remain constant. The interest rate will witness a constant decrease over time as the real money supply increases. Nominal money supply will remain constant over time. (c ) Short-run The India’s interest rate will increase. The price level will increase. The expected exchange rates not change. Current exchange rate will not change (d) Long-run The interest rate will increase The price level will increase The expected exchange rate will decrease The current exchange rate will decrease. (e) Overshooting refers to a situation in which the exchange is considered to be very volatile. This means that the foreign exchange market is inefficient and accurate prediction cannot be made. This phenomenon is evident in the India’s foreign exchange market. The dollar appears to be gaining a lot of strength against the rupee. 5. (a) A permanent decrease in the supply of Korea’s won will lead to a decrease in the value of the won against the Yen. In the short-run, there is a steady increase in the exchange rate. In the long run, a further decrease in the supply of the won will not have an impact on the exchange rate. (b) Korea operates under a managed floating exchange rate in which the government seeks to restrain the exchange rate movements so as to avoid rigidly fixed rates. A permanent decrease in the money supply will mean that the Korean currency will gain strength in the short run. An announcement will motivate investors to increase their spending rapidly with anticipation of a decrease in earnings. So if the government then fails to implement this policy after the announcement, it will be realized that the Korean won will depreciate in value with respect to the Japanese Yen. (c) A permanent decrease in the money supply that was not anticipated will result in a sudden increase in interest rates and this will prevent investors from investing in the foreign exchange market. This move will also result in a sudden decrease in the value of the Won against the Yen. (d) For a country to successfully increase the value of its currency, the interest rates must be increased. In the short run, other factors that increases the value of the currency such as increase in exports, low unemployment and high income cannot be attained in the short run .So the only way to increase the value of the currency is to raise the interest rates so as to encourage capital investments. As one of its monetary policy objective, the central bank aims at reducing the general price levels while at the same time ensuring that the value of the currency is made stable. One of the means of lowering the prices is by ensuring that there is an increase in the output level. A decrease in price level will ensure that value of the currency increases in the long run as the purchasing of power of the currency rises. Surprising the investors offers the best means of raising the value of the currency. This is because they do not get time to adjust to issues such as increase in interest rates. So those who had borrowed from financial institutions will have to bear the high interest rates which otherwise, they would have avoided. 8. Trilemma in the economy refers to a situation in which a country is faced with three policies to implement. However not all of them can be implemented effectively at the same time. The Federal Reserve is blamed to have caused the great depression in 1929 when it caused collapse of the stock market. The Federal Reserve aimed at reducing interest rates which was a good sign. The decreased interest rates increased the purchasing power of individuals’ thus increasing money supply in the economy leading to inflation. The Fed tried to control the situation by decreasing liquidity in the economy. This move greatly affected money held by the people. Secondly, it called for a reduction in the bank reserves. This made banks to reduce their lending resulting in a decrease in the amount of money circulation in the economy. Finally they decided to increase the discount rates making it almost impossible to access loans. These three actions are considered as a trilemma faced by the Fed in its approach to the great depression. All the three actions cannot be carried out effectively without experiencing a negative impact in the economy. Yet they all appear effective if considered independently but implementing all the three leads to disastrous effects in the economy. 10. ( a ) Increasing the money supply by 2,900% between July and Dec 1861 led to the exchange rate between the Confederate dollar and the Union dollar(EC$/U$)to increase. This is because; increasing money supply will lead to increase in the inflation rate making the confederate dollar to lose value against the Union dollar. Thus more Confederate dollar will be traded against one Union dollar. (b) The defeat of the Union’s army in the battle of Chickamauga led to a decrease in the exchange rate with the Confederate’s dollar gaining strength against the Union’s dollar. (c) The defeat suffered by the Confederate Army in the autumn of 1864 had a great impact on the on the economy of the Confederate states. Their gross domestic product went down forcing their currency to depreciate in value against the Unions dollar. Works Cited Freedman, David. Statistical Models: Theory and Practice. Cambridge: Cambridge University Press, 2009. Print. Mohanty, M. and Klau, M.Monetary Policy Rules in Emerging Economies: Issues and evidence, Heightfield: MTN press, 2004. Print. Obstfeld, M. and K. Rogoff. Foundations of International Macroeconomics, Cambridge, London: MIT Press,1996. Print Vander, Vaat. Asymptotic Statistics: The New Approach. Cambridge: Cambridge University Press, 1998. Print. Read More