Chapter 9 12 04 2013 Changes of exchange rates can effect economic growth causes recessions Porsche dealership cars usually range from 75 000 100 000 In February 1985 a us dollar averaged trading for 3 German marks The US dollar lost over 50 of its value The price went up Porsche almost went out of business because of exchange rate change Exchange Rates The basics Definition Price of a currency If the exchange rate is a price we can figure it out through supply and demand Exchange rate goes up the price goes up If something is less desirable price goes down o Price of a currency expresses in terms of units of another currency Exchange rate of the dollar in terms of euro Assumption to have an exchange you must have o Two countries U S and euro zone o Two currencies dollars and euro o Two exchange rates per per Always a minimum of two because of the definition price of a currency expressed in terms of ANOTHER Here we have two ratios per a per b Which is the price of the dollar A How to remember Euro PER dollar price of the dollar what is in the denominator It is a fraction B is the price of the Euro More definitions o Appreciation Price goes up If the dollar looks more desirable the price will go up so the dollar will appreciate o Depreciation Price goes down If the dollar look less desirable the price will do down so the dollar will depreciate Look at table on loose leaf Suppose you re an economic policy maker and boss comes up to you and ask is it better for the country to have a stronger dollar appreciated or better to have a weaker currency depreciated Normative statement Generally the right answer is it depends For every one dollar we are getting more of the other country s currency Relationship between exchange rate and import export prices o If a country s currency appreciates then Exports become more expensive Imports become cheaper o If a country s currency depreciates then Exports become cheaper Imports become more expensive ON LOOSE LEAF 12 04 2013 Chapter 26 12 04 2013 Aggregate Demand ALL OF THE BUYING Determinants of quantity of real GDP demanded o Real wealth effect As prices get cut in half income gets cut in half But what is happening to my wealth As price goes down money supply nominal money supply doesn t change but the real wealth has increased o Interest rate effect As aggregate price level goes down lower nominal interest rate Which results in cheaper to borrow o Exchange rate effect Suppose the bank cuts nominal interest rates suddenly will make the money look less desirable Dollar will depreciate if the nominal interest rate changes but that will causes exports to increase and imports to decrease making the overall curve to increase This wont have a huge impact on us but on a small country it will Determinants of aggregated demand policy changes monetary fiscal non policy In most countries monetary and fiscal are independent in big countries o Monetary policy Expansionary expand overall demand for goods and services Contractionary Increase demand increase economic Increase interest rates will cause monetary base of money supply to decrease o Fiscal policy determined by executive and legislative branches Government spending If government spending goes up everything else held constant overall GDP goes up Taxes A tax cut comes in because taxes get cut that means you have a higher take home pay which means you will spend more So your consumption and investment goes up real GDP goes up Social security payments The more it goes up the more the old people will buy making the GDP go Transfers up o Expectations what we think is going to happen in the future Policy cant control confidence Consumer confidence Consumption makes up 70 of GDP in the US Peoples confidence or expectations matter in spending today Expectation of the stability of their job Charles didn t want to do a lot of spending when he first started working here because he signed 1 year contracts In January he found out he was going to get to teach during the summer and his contract got renewed for the whole next year So he bought a new car because he knew he would have a job for an extra year Business confidence Only will expand a business if you think it will do good in a few years Business is more optimistic o Foreign economic growth Macroeconomic activity isn t a zero sum game Very large economies have the ability to export expansions and recessions If we have no money we spend less on everything no matter where it is produced If we don t buy stuff that people in china made then they get laid off because we couldn t afford it More economic growth in other countries they will spend more money which means they would buy more stuff from the US o Exchange rate change Aggregate supply Short run SRAS vs Long run LRAS Determinant of quantity of real GDP supplied o Short run o Long run Determinants of SRAS o Labor cost wage push o Other input cost supply shocks o Productivity o Expected future aggregate price level Chapter 26 Chapter 32 12 04 2013 IN LONG RUN the labor market is an equilibrium Equilibrium no incentive to change what your doing Aggregate Supply Short run SRAS vs Long run LRAS Determinant of quantity of real GDP supplied o Short run Wages are fixed As the aggregate price level is going up output prices are changing more rapidly than input prices This makes you want to produce more in the short run Causes business to be more willing and able to increase Aggregate supply to increase in the short run Labor cost o Long run Equilibrium Input cost will catch up Determinants of SRAS o Labor cost wage push If labor cost falls profit goes up business sell more o Other input costs supply shocks If other input cost fall then profit goes up and sell more o Productivity Goes up then profit goes up o Expected future aggregate price level Expect prices to go down in the future Equilibrium Short run AD SRAS o Case 1 Recession Equilibrium isn t the same as the goal and it is less than the full employment IN the labor market we are experiencing cyclical unemployment There is a gap separation between in the goal and actual output We call the gap RECESSIONARY gap o Case 2 Expansion labor market Above Full Employment There is a shortage in the The problem is there is not enough people to fill the jobs The gap is called INFLATIONARY gap This is going to lead to inflationary pressures in the economy o Case 3 Full employment There are people structurally and frictionally unemployed but not cyclical Everything is