Week Five Discussion Questions

1. Explain how foreign exchange rates are determined. How do changes in interest rates, inflation, productivity, and income affect exchange rates? What are the advantages and disadvantages of a weak versus a strong dollar for imports, exports, international and domestic markets?

Exchange rates are the rates that a currency from one country trades for the currency of another (Colander, 2010). These rates can be adjusted by a country purchasing and selling foreign currencies or other international reserves.

Changes in interest rates, inflation, productivity, and income all affect the exchange rate. If a country has a higher inflation rate the demand for foreign goods become cheaper, which increases foreign currency thereby creating a higher demand for foreign currency (Colander, 2010). A country’s increase in interest rates also increases the demand for said country’s currency, which increases the value of this currency (Colander, 2010). When a country’s income reduces the demand for imports falls with it (Colander, 2010). This in turn causes the country’s exchange rate to reduce from lack of demand.

A strong dollar increases the demand for exports and international markets. Higher valued exchange rates increase the amount of investors from foreign nations, which then increases the domestic markets (Colander, 2010).

Reference

Colander, D. C. (2010). Macroeconomics (8th ed.). Boston, MA: McGraw-Hill/Irwin.

2. Who benefits from a tariff or quota? Who loses? Do domestic markets benefit from protectionist trade policies? How do protectionist trade policies affect a government’s wealth and fiscal policy?

When a tariff is placed on a good it increases the price of the imported good thereby reducing the demand for the import (Colander, 2010). This increases demand on domestic goods by increasing the prices of foreign. Quotas are similar to a tariff in that they limit the demand for imports (Colander, 2010). The difference is the imports are limited by quantity rather than a tax. The affects of tariffs and quotas on the exporter of the goods is larger than that of the importer. The exporter is essentially stifled in the amount of goods they can export thereby restricting the exporting country’s economy.

The intent behind tariffs and quotas is to increase the demand for domestic goods while decreasing that of foreign. This can build the domestic economy but if it is not done carefully it can adversely affect exports which will create a lull in the domestic economy as well.

Tariffs create a much larger amount of revenue for the government than that of a quota. Since a quota is a limit on goods it does not generate revenue, however a tariff is a tax, which generates revenue. This revenue makes a tariff a much more viable option to the government than that of a quota.

Reference

Colander, D. C. (2010). Macroeconomics (8th ed.). Boston, MA: McGraw-Hill/Irwin.