Lecture 6.docx

Lecture 6 Part 1: World market- No Trade

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countries: Home and foreign There is no trade Wheat No shipping costs Only difference is price o Where two lines meet: Equilibrium o That will be the quantity and price of the product in the market The equilibrium price is cheaper in Foreign market Home country o Why don’t we make a trade and get the goods for cheaper? o We could also make a free trade agreement (FTA) o FTA could hurt the businesses in your home country Foreign country o Why trade? o They would be able to sell it in a higher price o Industry will grow o There will be competition

Part 2: World Market- Trade

Two

 Home market o They wouldn’t be willing to pay more for a product in foreign market o As the price for imports go down, demand goes up. o PFA is the floor price o Foreign market fills the gap between the demand and supply in Graph 1 at the PW o Prices went up  Demand- Happy  Suppliers- Not happy  Foreign o Why should I sell it at a lower price (PFA ) when I can sell it at (Graph 2- PW ) o Foreign market has a surplus. o That surplus is equal to the gap in graph 1. o Prices went up  Demand- not happy  Suppliers- Happy  Next step: Put tariffs on wheat. Part 3: World Market- Trade with a Tariff

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Tariff depends on how big the economies are. Tariff is a barrier for trade. Home market isn’t affected by the tariff. Home markets imports go down. There is still a gap but not as much as before. They will import less. Foreign market will get their surplus and export it to the home market. Imposing tariffs: Creates a sense that no one’s happy, they are better off than they were 10 years ago.

Exchange Rate Topics:  Terminology: o Direct quote: How much does it cost in my currency to get a foreign currency  To get 1 euro, how much CAD should I give.

o Indirect: I have one, how much that is going to get me in the foreign currency  I have 1 CAD, how much euros I can get with it. o Bid Rate: Dealer is willing to buy it from you o Ask Rate: Dealer is willing to sell to you  Difference between bid and ask is the profit: The Spread o Arbitrage: Riskless profit. Finding free money  Geographic arbitrage  No additional cost  Two rates o NY: 2USD/ 1GBP o London: 1.8 USD/ 1 GBP  Exchange 1 GBP for 2 USD in NY, sell 2 USD in London, gain 1.11 G  You do it as much as you can and as fast as you can until it reaches an equilibrium price. o Floating exchange rate: Exchange rate moves around. o 7-8 years ago CAD was better than US. So when you go shopping in US, you could buy more. o Every 1 USD you can get 1.3 CAD o 1.3 USD/CAD means  1.3 USD/ 1 CAD  Measuring a change in exchange rates o Midterm: no formula sheet.  Base foundation formula:

 (1.31705-1.1159)/ 1.1159 = 0.180258x 100 =18% o Beginning- Ending/ Beginning (Standard way) o You can also do Ending- Beginning/ Ending  But you have to inverse the rates.