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Disequilibrium Due to Government Regulation
SupplyP
Q
SupplyP
Q
Demand P
Q
Demand P
Q
(A) (B) (C) (D)
Demand Demand Supply Supply
Current Price Current Price Current Price Current Price
Supply Limit
Home Abroad
Home Abroad
Home Abroad
Currrent account = trade balance= net exports
MoneyReal goods and services - imports
Real goods and services - exportsCAPITAL ACCOUNT
Titles to American wealth sold to foreignersUnilateral transfers
Money
Money
Titles to foreign wealth sold to Americans
BALANCE
OF
PAYMENTS
$ in Foreign Exchange Mkt ¥ in Foreign Exchange Mkt
Price of a Dollar Price of Yen
¥/$ $/¥
1
10
100
1000
70 72 74 76 78 80 82 84 86 88 90 92 94 96
Value of the Mexican Peso in $
COUNTRY GDP per Person (1993)U.S. $24,580Canada $18,940Mexico $3,679
Argentina $7,505Brazil $3,528Chile $3,067Cuba $1,959Colombia $1,339
Japan $34,160South Korea $7,368China $1,738Phillipines $791
0
20
40
60
80
100
120
140
160
180
70 72 74 76 78 80 82 84 86 88 90 92 94 96
Unit Labor Costs in Mexico (AER,May 1996
-70
-60
-50
-40
-30
-20
-10
0
70 72 74 76 78 80 82 84 86 88 90 92 94 96
Percentage Change in Value of the Mexican Peso (per $)
-8000
-6000
-4000
-2000
0
2000
4000
6000
70 72 74 76 78 80 82 84 86 88 90 92 94 96
U.S. MerchandiseTrade Balance w/ Mexico
- 8 0 0 0
- 6 0 0 0
- 4 0 0 0
- 2 0 0 0
0
2 0 0 0
4 0 0 0
6 0 0 0
7 0 7 2 7 4 7 6 7 8 8 0 8 2 8 4 8 6 8 8 9 0 9 2 9 4 9 6
U.S. MerchandiseTrade Balance w/ Mexico
- 7 0
- 6 0
- 5 0
- 4 0
- 3 0
- 2 0
- 1 0
0
7 0 7 2 7 4 7 6 7 8 8 0 8 2 8 4 8 6 8 8 9 0 9 2 9 4 9 6
Percentage Change in Value of the Mexican Peso (per $)
- 8 0 0 0
- 6 0 0 0
- 4 0 0 0
- 2 0 0 0
0
2 0 0 0
4 0 0 0
6 0 0 0
7 0 7 2 7 4 7 6 7 8 8 0 8 2 8 4 8 6 8 8 9 0 9 2 9 4 9 6
U.S. MerchandiseTrade Balance w/ Mexico
- 7 0
- 6 0
- 5 0
- 4 0
- 3 0
- 2 0
- 1 0
0
7 0 7 2 7 4 7 6 7 8 8 0 8 2 8 4 8 6 8 8 9 0 9 2 9 4 9 6
Cheaper peso means* more imports from Mexico* fewer exports to Mexico==> larger U.S. Trade deficit
- 8 0 0 0
- 6 0 0 0
- 4 0 0 0
- 2 0 0 0
0
2 0 0 0
4 0 0 0
6 0 0 0
7 0 7 2 7 4 7 6 7 8 8 0 8 2 8 4 8 6 8 8 9 0 9 2 9 4 9 6
U.S. MerchandiseTrade Balance w/ Mexico
- 7 0
- 6 0
- 5 0
- 4 0
- 3 0
- 2 0
- 1 0
0
7 0 7 2 7 4 7 6 7 8 8 0 8 2 8 4 8 6 8 8 9 0 9 2 9 4 9 6
Percentage Change in Value of the Mexican Peso (per $)
U.S. Surplusesmean Mexicandeficits
Mexican Trade Deficits MUST BE FINANCED with hard currency (U.S. $)
BUT, Greater Demand for U.S. Dollars ($)
MEANS A Higher Value for the U.S. Dollar ($) MEANS
A LOWER VALUE FOR THE PESO
In 1994 the economy is perfectly set up for another devaluationof the Peso
Add the additional fuel of:- An armed insurrection combined with terrorism.- The assasination of the leading presidential candidate.- Political scandals- Kidnappings of prominent businessmen - A fixed nominal exchange rate.- More financial transactions.
Mexico attempted a devaluation of 15% on December 20, 1994
Speculative interests unloading the peso in New York accelerated the decline
0
0.2
0.4
0.6
0.8
1
1.2
75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95
THE VALUE OF THE YEN ($/yen)
Year
0
0.5
1
1.5
2
2.5
3
75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95
THE VALUE OF THE DOLLAR (yen/$)
Year
0
0.02
0.04
0.06
0.08
0.1
0.12
0.14
0.16
76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95
cpi %dPrime
U.S. INFLATION (CPI) & U.S. INTEREST RATES (PRIME RATE)
(% annual change)
Year
0
0.02
0.04
0.06
0.08
0.1
0.12
0.14
0.16
76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95
JapanU.S.
INTEREST RATES (PRIME RATE): U.S. and Japan
(% annual change)
Year
0
0.02
0.04
0.06
0.08
0.1
0.12
0.14
76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95
U.S.Japan
INFLATION (CPI): U.S. and Japan(% annual change)
Year
0
0.02
0.04
0.06
0.08
0.1
0.12
76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95
interestinflation
JAPANESE INFLATION (CPI) & INTEREST RATES (PRIME RATE)
(% annual change)
Year
-2
-1
0
1
2
3
4
5
6
7
76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95
U.S.Japan
REAL INTEREST RATE: U.S. and Japan(% annual change)
Year
-2
-1
0
1
2
3
4
5
6
7
8
76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95
Inflation DifInterest Dif.
Difference in U.S. and Japanese Rates (% annual change)
Year
Foreign Price / value of the dollar = U.S. price
1872.55 yen / 220.30 yen = $8.50 1.0 $
U.S. Price * value of the dollar = Foreign price
$8.50 * 400 yen = 3400 yen 1.0 $
Average Profit = Price - Unit cost Price in US $- (Unit cost in Yen/ value of yen)
At 400 yen per dollar$4.50 = $12.00 - (3000 yen / 400 yen per dollar)
At 400 yen per dollar$2.00 = $12.00 - (3000 yen / 300 yen per dollar)
At 400 yen per dollar-$3.00 = $12.00 - (3000 yen / 200 yen per dollar)
Alternative Sources of Telephones: 1981
ROW SOURCE U.S. CANADA JAPAN S. KOREA
1 Price $8.50 C$9.60 Y1806.46 W5888.40
2 Exchange Rate (per $) - 1.20 220.30 701
3 Price (in $) $8.50 $8.00 $8.20 $8.40
4 Cheapest AlternativeSource (in $) $8.00 $8.20 $8.00 $8.00
5 Opportunity Loss(in $) $.50 -$.20 $.20 $.40
SOURCING COSTS REFLECTING CHANGES IN EXCHANGE RATES (per phone)
YEAR U.S. (1)
CANADA (2)
JAPAN (3)
S. KOREA (4)
SAVINGS (5)
1981 $8.50 $8.00 $8.20 $8.40 $.00
1982 $8.50 $7.78 $7.28 $7.86 $.22
1983 $8.50 $7.78 $7.61 $7.40 $.60
Savings From Three Types of Flexibility:I. Opportunity saving buying from Canada instead of the U.S.= 300,000 phones * ($8.50-$8.00 per phone)=$150,000
II. Opportunity saving from one year rather than three year contracts(which allows swithcing to lowest cost producere each year)= 100,000 phones in 1982 * ($8.00-$7.28) + 100,000 phones in 1983 * ($8.00-$7.40) =$132,000
III. Opportunity saving from storing (buying from Japan in 1982 to meet 1983 needs, even after $.07 costs of inventories)=100,000 phones in 1982 * ($7.40-$7.28+.07)=$5,000
TOTAL OPPORTUNITY SAVING = $287,000
INTEREST AND EXCHANGE RATE CHANGESStart: Japanese invest 1000 yen in 1985 at 215.9 yen per dollar with a gauranteed interest rate of 7.97%.
End: Japanese liquidate their investment at 178.55 yen in 1986
Calculation of gain:
1000 yen * 1 *1.0797 * 178.55 = 892.92 yen 215.9
Opportunity loss: Could have earned 1064.7 yen by investing at home.
SAVINGS THROUGH DIVERSIFICATION
YEAR Average Price (1)
Average Saving(2)= $8.50 - (1)
Total Saving over100,000 Phones(3) = (2)*100,000
1981 $8.275 $.225 $22,500
1982 $7.855 $.645 $64,500
1983 $7.8225 $.6775 $67,750
TotalSavings
$154,750
00.77 1.05
3.4 3.75 3.98 4.45 4.565.5
6.02
7.48.26
0
-1.95-3.05
-4-4.6 -5.05 -5.4
-6.37
-7.75
-12.05-12.7
-13.75
-15
-10
-5
0
5
10
Nov\4 Dec\1 \2 \3 \4 Jan\1 \2 \3 \4 \5 Feb\1 \2
SPOT AND FUTURES MARKET PRICES FOR OIL: 1975-76
19761975