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Topic 6.5: Changes in the Foreign Exchange
Market and Net Exports
Learning Objective: Explain (using graphs as appropriate) how changes in the value
of a currency can lead to changes in a country’s net exports and aggregate demand.
Skill 3.A: Determine the outcome of an economic situation using economic concepts,
principles, or models.
This lesson will address the following:
- Connecting changes in currency values to
changes in trade among nations
- Connecting changes in net exports Unit 6 will
to aggregate demand not appear
on this year’s
exam
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LESSON OVERVIEW
DIVIDER SLIDE
TEACHER NOTES & REQUIREMENTS
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FRQ from 6.4
2010 Form B Q. 2
2. The central bank of the country of Sewell sells bonds on the open market.
a) Assume that banks in Sewell have no excess reserves. What is the effect of the central
bank’s action on the amount of customer loans that banks in Sewell can make?
b) Using a correctly labeled graph of the money market, show the effect of the central
bank’s action on the nominal interest rate in Sewell.
c) What is the effect of the central bank’s action on each of the following in Sewell?
i. Price level
ii. Real interest rate. Explain.
d) Given your answer in part (c)(ii), how is the international value of Sewell’s currency,
the ono, affected? Explain.
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FRQ from 6.4
2010 Form B Q. 2
2. The central bank of the country of Sewell sells bonds on the open market.
a) Assume that banks in Sewell have no excess reserves. What is the effect of the central
bank’s action on the amount of customer loans that banks in Sewell can make?
Nominal
Bank loans
Interest Rate
will decrease MS1 MS
b) Using a correctly labeled graph
of the money market, show the
effect of the central bank’s action
i1
on the nominal interest rate in
Sewell.
i
MD
M1 M Quantity of
Money
FRQ from 6.4
2010 Form B Q. 2
2. The central bank of the country of Sewell sells bonds on the open market.
c) What is the effect of the central bank’s action on each of the following in
Sewell?
i. Price level The price level will fall
The real interest rate will rise
ii. Real interest rate.
An increase in the nominal interest rate and a
Explain.
decrease in the price level, the real interest rate
increases.
d) Given your answer in part (c)(ii), how is the international value of Sewell’s
currency, the ono, affected?
Explain.
The ono will appreciate, because the increase in the demand for Sewell’s
financial assets causes an increase in the demand for the ono.
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Review: Net Exports and Aggregate Demand
Review: Remind yourself of the connection between Net Exports and AD
Price SRAS
LRAS
Level
NX = X – M
P1
Exports (X): P
produced domestically,
P1
purchased abroad
Imports (M):
produced abroad,
AD1
purchased domestically
AD
AD1
Y1 Y Y1 Yf GDPr
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What You Need to Know
6.5: FX Markets, Net Exports, and Aggregate Demand
CONSIDER:
Exchange rates tend to change more frequently than prices for goods/services
HYPOTHETICAL:
Assume trade between the US and Rankinland (2012 FRQ)
One month ago: $1 purchased 1 bera US$ appreciates
Today: $1 purchases 2 bera Bera depreciates
The price of a box of Rankinland chocolates is 12 bera
The price of a box of American chocolates is $12
One month ago: $1:1 bera Today: $1: 2 bera
One month ago: $12 to buy chocolates Today: $6 to buy chocolates
Americans buy more Rankinland chocolates NXR increase
One month ago: 1 bera : $1 Today: 1 bera : $0.50
One month ago: 12 bera to buy chocolates Today: 24 bera to buy chocolates
Rankinlanders buy less American chocolates NXUS decrease
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6.5: FX Markets, Net Exports, and Aggregate Demand
The interaction of buyers and sellers exchanging the currency of one country for the currency of
another determines the equilibrium exchange rate in a flexible exchange market and influences the
flow of goods, services, and financial capital between countries.
US$ appreciates Bera/$ S
Bera depreciates
Rankinlanders buy less US chocolates
e 1
NXUS decrease e
Connect change in NX to
Aggregate Demand
D1
United States AD decreases
D
- Output decreases
- Price Level decreases Q Q1 Q($)
- Employment decreases Factors that cause a currency to appreciate cause that country’s
exports to decrease and its imports to increase.
As a result, net exports will decrease.
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6.5: FX Markets, Net Exports, and Aggregate Demand
The interaction of buyers and sellers exchanging the currency of one country for the currency of another
determines the equilibrium exchange rate in a flexible exchange market and influences the flow of goods,
services, and financial capital between countries.
France and Switzerland are trade partners
About a year ago €1 : CHF1.14
Now €1 : CHF1.05
Translate the change in exchange rate
The Swiss Franc appreciated (up in value)
The Euro depreciated (down in value) AD INCREASES
How might this effect trade between France and Switzerland?
Swiss goods more expensive for French residents
French goods more affordable for Swiss residents
Swiss Net Exports decrease
French Net Exports increase
Connect to Aggregate Demand
AD DECREASES 14
6.5: FX Markets, Net Exports, and Aggregate Demand
HK$/ NZ$ depreciated NZ$/ HK$ appreciated
NZ$ HK$
S S
S1
e1
e e
e1
D1
D D
Q Q1 Q(NZ$) Q Q1 Q(HK$)
New Zealand and Hong Kong are trade partners
How does this effect New Zealand net exports and AD?
NX increase AD increases
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6.5: FX Markets, Net Exports, and Aggregate Demand
How do we determine the outcome of an economic situation using economic concepts,
principles, or models? (Skill 3.A)
An increase in the international value of the United States dollar will most likely
benefit
A domestic producers of premium wines sold to people in other countries
B currency traders holding large quantities of yen
C German citizens vacationing in the United States
D Canadian citizens expecting to purchase real estate in the United States
E retired United States citizens living overseas on their social security checks
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6.5: FX Markets, Net Exports, and Aggregate Demand
How do we determine the outcome of an economic situation using economic concepts,
principles, or models? (Skill 3.A)
An increase in the international value of the United States dollar will tend to cause
A United States exports to fall
B the national income of the United States to increase
C employment in the manufacturing sector of the United States to increase
D the inflation rate in the United States to increase
E the growth rate of the United States economy to increase
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6.5: FX Markets, Net Exports, and Aggregate Demand
How do we determine the outcome of an economic situation using economic concepts,
principles, or models? (Skill 3.A)
Assume that Canadian consumers increase their demand for Mexican financial
assets. How would the international supply of Canadian dollars, the value of the
Mexican peso relative to the Canadian dollar, and Canadian net exports to Mexico
change?
Supply of Canadian
Value of the peso Canadian net exports
dollars
A Increase Increase Increase
B Increase Increase Decrease
C Decrease Increase Decrease
D Decrease Decrease Increase
E No Change Increase Decease
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6.5: FX Markets, Net Exports, and Aggregate Demand
How do we determine the outcome of an economic situation using economic concepts,
principles, or models? (Skill 3.A)
If a nation’s currency appreciates relative to that of its trading partners, what will
happen to the nation’s exports, imports and aggregate demand?
Exports Imports Aggregate Demand
A Increase Decrease Increase
B Increase Increase Increase
C Decrease Increase Increase
D Decrease Increase Decrease
E Decrease Decrease Decease
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Topic 6.5: Changes in the Foreign Exchange
Market and Net Exports
Learning Objective: Explain (using graphs as appropriate) how changes in the value
of a currency can lead to changes in a country’s net exports and aggregate demand.
Skill 3.A: Determine the outcome of an economic situation using economic concepts,
principles, or models.
This lesson addressed the following:
- Connecting changes in currency values to
changes in trade among nations
- Connecting changes in net exports Unit 6 will
to aggregate demand not appear
on this year’s
exam
21
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2011, Q2, part b
2. Japan, the European Union, Canada, and Mexico have flexible exchange rates.
b. Suppose … the real interest rate in Canada increases relative to that in
Mexico.
i. Using a correctly labeled graph of the foreign exchange market for the
Canadian dollar, show the effect of the change in real interest rate in
Canada on the international value of the Canadian dollar (expressed as
Mexican pesos per Canadian dollar).
ii. How will the change in the international value of the Canadian dollar that
you identified in part (b)(i) affect Canadian exports to Mexico? Explain.
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