National University of Ireland Galway First Semester 2007 08 EC 382 International Economics Q A 1 Could you please go over why the balance of payments is zero and more specifically why does an Irish purchase of a US good lead to a capital inflow for Ireland Answer Balance of payment is zero because there are two sides to each transaction If you buy a car from the US for 10 000 current account you send 10 000 to the US That means that US holding of Irish assets euros goes up by 10 000 capital account So in this case current account has a deficit of 10 000 and capital account has a surplus of 10 000 2 Should we focus on topics you have done since the last exam and is dar much point going back over the topics you have already examined us on Answer This exam is comprehensive That means that it covers everything Please study everything 3 Hi Jackie I have a few questions for you In week 11 with the example of interest rate parity I don t understand how at the end Dollar sells at a 2 forward discount Interest rate in US is 2 point higher than in Ireland Could you go through the steps in more detail please and the concept of forward supply of currency Also could you please clarify whether the following are stocks or flows GDP Price Index Exports and Unemployment Answer First about the forward market Say you want to buy a US made car directly from the US The sellers say he wants 10 000 in 3 months You are afraid that if you wait for 3 months to buy dollars dollar may have appreciated and you end up paying more for the car than you expect So you will buy dollars in the forward market today This is a market where you go and order dollars to be delivered to you at a specific rate know to you in 3 months That way you know exactly how many euros you will have to spend on the car This market is a separate from the spot market where you buy dollar on spot So the rates may be different For example the spot exchange rate may be 2 per euro and the forward rate maybe 2 05 per euro In this case we say dollar is selling at a forward discount Or the forward rate could be 1 90 per euro In this case we say dollar is selling at a forward premium Second about the interest rate parity It refers to a situation where the difference between US and UK interest rates on similar assets is equal to the difference between forward and spot exchange rates Here is an example Yearly interest rate in the US is 14 and in UK 12 Spot exchange rate is 2 per pound and one year forward rate is 2 04 per euro That means that pound is selling at 2 forward premium 2 04 2 2 0 02 or 2 This is a parity situation because no UK investor has an incentive to invest in the US Why Say I am a UK resident and have 100 to invest I will buy 200 dollars on spot I know that I will make 14 interest in a year So I know that I will have 228 in a year And I sell 228 in the forward market for 112 228 2 04 Did I make anything extra by investing in the US No because I could have made 12 interest at home in UK Third GDP and exports are measure over a period of time So they are flow Price index and unemployment are measured at a given point in time So they are stock 4 I was just wondering on slide 28 in class 7 does Cs go down by A C goes to government D is dead weight loss B is inefficiency A goes to Could you correct any of my errors Answer Consumer surplus goes down by a b c d a goes to domestic supplier b is loss in efficiency dead weight loss All or parts of c may go to domestic government domestic importer or foreign exporter d is also dead weight loss