Posts tagged review

Exam Review Blog Posts: Exchange Rates

Questions:

(a) Explain three factors which may cause changes to occur in a country’s exchange rate under a floating exchange rate system.

(b) Evaluate the likely impact on a country’s economic performance of a substantial depreciation of its exchange rate.

1. The question (a) is asking for three factors that affects the floating exchange rate system. Also, the question (b) is asking the test taker to evaluate on the effect due to the depreciation of the exchange rate.

2. Floating Exchange Rate: Where the exchange rate is floating (as are all major currencies in the world), it will be determined by market forces – that is supply and demand. As in any other market, the rate will change constantly to reflect how much of the currency is being traded. However, what determines the supply and demand for the currency? Let’s take the Baht (the Thai currency) as an example and look at the factors that affect supply and demand and therefore the equilibrium exchange rate. (Triple A)

3. Governments can use exchange rates to affect economic performance. A rising exchange rate, which is often linked to an increase in base interest rates, leads to exports becoming more expensive but imports falling in price. This would reduce part of the inflationary pressure within an economy. A fall in the exchange rate would lead to the reverse and might help domestic businesses export more. (Triple A)

4.

  • Floating Exchange Rate: the exchange rate system is affected by the supply and demand of the currency exchange market.
  • Depreciation of the Exchange Rate: this usually occurs when either the supply of the currency increases or the demand of the currency decreases.

5.

This is the diagram for the depreciation of the currency as a result of the increase in the supply of the currency from S1 to S2. The quantity of the currency increases from Q1 to Q2, however, the value of the currency in terms of another currency goes down. This is why the currency depreciates when the supply of the currency increases.

The currency can depreciate also when the demand for the currency decreases from D2 to D1. The quantity of the currency demanded decreases from Q2 to Q1 and the value of the currency decreases from $0.35 to $0.25. This is why the currency depreciates when the demand for the currency decreases.

As the currency depreciates, the exports will increase and the imports will decrease. This will balance of payment and decrease the current account. The country will be in the trade surplus, however.

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Naked Economics

While reading the book Naked Economics by Charles Wheelan in the pages from 17 to 22, there were several points made.

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1. The market economy is a powerful force for making our lives better.

  • Competition in business firms lowers the price and the cost of a product or a service, thus making the lives of costumers better.

2. Market is amoral.

  • Market system does not protect the poor.
  • Market system lacks moral in a process of rewarding scarcity and pricing any valuable product.

3. Price is the means of allocating scarce resources.

  • Since there is a limited amount of resources, prices act as a medium of allocating the resources. The one pays more than another gets to be an owner of that resource.

4. Through pricing, most market are self-correcting itself.

5. If a government fixes price in a market system, private firms will find

some other ways to compete.

  • When OPEC decides to cut off the production of oil, the price goes up. However, as the price goes up, some of its members start to opt out and cheat on that promise in order to sell their oil at best price.

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The Worldly Philosophers

1. How is scarcity and survival intertwined?

In the book, a man looks at survival a problem as a member of a society related with scarcity. The fact that he is still alive seems to prove that the man has solved the problem of survival, however, the scarcity, or existence of want and misery, seem to undermine  the solution to the problem. Scarcity of resources and people’s desire for more creates problem. Economics study the scarcity of resources in a society and studies the society’s survival or endurance relating scarcity to it.

2. What are advantages and disadvantages of the two ways societies have been organized in the past?

In the primitive society, the reality that opportunity cost of not working was death forced people to work and cooperate as a member of society. The advantage of this society is that it forces everyone to work. However, the disadvantage of it is a struggle between life and death.

In advanced society, only half of the population never does anything “productive,” such as working in factories or mines. The advantage of this society is that work is not a struggle for survival like in the primitive society. However, the disadvantage of the society is that if even a small portion of the “productive” work force performed poorly or refused to work, it would affect and dismantle the structure of the society.

3. Why was there no need for economists throughout most of history?

Throughout history, most of societies had traditional economy, which means that occupation is passed down to generations. With everybody having fixed work, there was no need for economics and economists for the society did not need them to comprehend their economy or social structure.

4. Why do you think the economic  revolution was so disturbing?

In a traditional society, everything was obvious; every men had their fixed occupation. However, the idea of market system had dubious and unclear aspects. So the revolution to settle market system in these societies would have been very disturbing as it dismantled the traditional social structure. Also, it might have added uncertainties to people’s roles or occupations.

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