Last time it was trade. This time it's money. More specifically, we'll look at international currencies and the role they play in the world's economy. Here are some definitions that you will need to understand:
Exchange Rates: The value of currencies worldwide is provided by exchange rates, which tell you what each currency is worth in relation to other currencies. In simple terms, a currency is worth what people will pay for it. Exchange rates are constantly adjusted to reflect markets.
- Fixed exchange rates: After the 1930s,
most countries abandoned the gold standard. Instead, each country's
government "fixed" the value of their currency, deciding what it would
be worth. (For example, the British decided to exchange their pound
into US dollars at a rate of $2.40 per pound.)
- Floating exchange rates:
After 1973, international agreements on fixed rates expired, and
currencies began to have their value decided in the market. A
currency's value will "float" up or down. (An estimated $3+ trillion
dollars in currencies are traded every day in the world's foreign
Purchasing Power refers to what money can actually buy in each country- calculating its purchasing "power". Purchasing Power Parity (PPP) would be when a currency can buy the same basket of whatever in any country.
Playing with "Purchasing Power Parity (PPP): I think you'll like this stuff...
To do the following, you need a copy of "cross currency" rates. You can get one from the Benchmark Currency Rates page at Bloomberg.com. (Yes, that's the same Bloomberg as in the Mayor of New York City.)
Economists refer to purchasing power parity to describe why, over time, the dollar price of a good in one country should equal its dollar price in all other countries. The notion that a particular type of cordless telephone should sell for the same dollar price in the United States as it does in, say, Japan and Great Britain, makes sense if you think about supply and demand in world markets. Suppose that the telephone sells for $29.99 in the United States, 2500 yen in Japan, and 20 pounds in Great Britain.
Let's figure out in which country the dollar price of the cordless phone is lowest?
1. What is the exchange rate between the Japanese yen and the United States dollar?
2. What is the exchange rate between the British pound and the United States dollar?
3. Calculate the dollar price of the cordless phone in Great Britain.
4. Calculate the dollar price of the cordless phone in Japan.
5. In which country is the dollar price of the cordless phone the lowest?
6. In which country is the dollar price of the cordless phone the highest?
So, what does "purchasing power parity" suggest that an entrepreneur could do to earn profits?
Of course, purchasing power parity theory suggests that price
adjustment will continue until the dollar price of cordless phones is
the same in each country. This price equalization is an example of
purchasing power parity. Note that it works best for close substitutes
that can be traded among countries over long periods of time.
Foreign Exchange map: This is a service from The Economist. Once you get to the page, you have to "Launch the Map". Give it a minute or so to load itself. After that, follow the directions from the first page. Try several comparisons between countries and over time periods. (Be sure I also show you the Big Mac Index.)
We'll start our shift to 21st Century topics early next week by looking at poverty and development economics. We'll at least get a start on this material today.
HOMEWORK for next session - Monday, May 2nd
Blog Entry #6 (Chapters 10 and 11) was posted and it will be due before class time on Monday.
I'm asking you to have Chapter 13 read for Monday. (I will post the final required blog for Naked Economics, but I'll have you read the Epilogue as well. There will be a bonus blog entry there you can do for extra credit if you want.)
Blog Entries #1 - #5 can still potentially receive full credit if posted before next Wednesday's class time. After that, you will only be able to receive a maximum of 4 out of 5 for any of those.
I'm looking at doing the Macroeconomics/International Economics Exam on Thursday, May 5th. There is a review page posted on the blog that you may find useful. You can again bring in a sheet of notes.
FYI - NEXT Friday, May 6th (not tomorrow), you'll be able to head to College Counseling after checking in with me to celebrate College Choice Day. They'll have some refreshments and supplies for you to make a pennant with to hang next to your picture. (I'll treat it as sort of a catch-up day and be available to help anyone with that.)