Activity Questions

1. Are you in favor or against Free Trade? Provide an elaborate argument by reading
Chapter 10. Use other references if necessary. Cite your sources. (30 points)

When we talk about Free Trade, it is complex and can have both positive and negative
effects depending on various factors. But, in my own opinion I am favor with Free Trade,
because it primarily leads to economic growth and development. In the principle of
economics, free trade on the international level is no different from trade between
neighbors, towns, or states. However, it allows businesses in each country to focus on
producing and selling the goods that best use their resources while other businesses
import goods that are scarce or unavailable domestically. That mix of local production
and foreign trade allows economies to experience faster growth while better meeting
the needs of its consumers. According to the economist David Ricardo in his book, "On
the Principles of Political Economy and Taxation." He argued that free trade expands
the diversity and lowers the prices of goods available in a nation while better exploiting
its homegrown resources, knowledge, and specialized skills (Investopedia, 2023).
There are also arguments about additional gains from Free Trade, it says that Free
Trade provides entrepreneurs with incentive to seek new ways to export or compete
with imports, it also offers more opportunities for learning and innovation than are
provided by system of “managed” trade, where the government largely dictates the
pattern of imports and exports. It also suggests that a move of free trade makes the
economy as a whole more efficient by shifting the industrial mix towards firms with
higher productivity (Krugman et. al, 2018). In free trade, it will be significantly bring a
lots of benefits in the people living conditions, as they have greater access to low-priced,
high-quality goods and lower prices overall. Due to free trade it allows specific country to
have greater efficiency and innovation in production, increased economic development
and living standards, and overall economic growth.

2. Explain how depreciation and appreciation of the domestic currency affect patterns
of import and export. (30 points)

-In depreciation of a currency, it occurs when the value of a currency falls in comparison
to the value of another currency. On the other hand, appreciation occurs when the value
of a currency increases in comparison to the value of another currency. This two
components significantly affects patterns of import and export when one of them occurs at
certain time. Depreciation of the domestic currency can have significant effects of pattern of
import ad export. It tends to increases the cost of import, a depreciation of the domestic
currency makes imports more expensive since the same amount of foreign currency buys fewer
units of the domestic currency. This can lead to a decrease in the demand for imports as they
become relatively more expensive compared to domestic goods. It also Increases the
competitiveness of exports, it makes domestic goods cheaper for foreign buyers, as they can
now purchase more units of the domestic currency with their own currency. This leads to an
increase in demand for domestic exports, as they become more competitive in foreign markets.
The other effect is reduces trade deficits, the increase in export competitiveness and the
decrease in import demand can lead to a reduction in the trade deficit, as exports increase and
imports decrease.
Appreciation of the domestic currency can affect patterns of import and export in several ways,
in terms of impact on imports when the domestic currency appreciates, imported goods become
cheaper for domestic consumers. This can lead to an increase in imports as consumers take
advantage of the lower prices. Also in terms of Impact on exports conversely, the appreciation
of the domestic currency can make exports more expensive for foreign consumers. This can
lead to a decrease in demand for domestically produced goods and a decline in export volumes.
Lasltly, the shifts in trade balance is affected, as a result of the impact on imports and exports,
the appreciation of the domestic currency can lead to a shift in the trade balance. An increase in
imports and a decrease in exports can lead to a trade deficit, where a country is importing more
than it is exporting. This can have broader implications for the economy, as it may lead to a
decrease in domestic production and employment in export-oriented industries.

3. Describe the players and transactions happening in the Foreign Exchange market.
(30 points)

- Foreign Exchange market, the market in which international currency trades take
place. The major participants in the foreign exchange market are commercial banks,
corporations that engage in international trade, nonbank financial institutions such as
asset-management firms and insurance companies, and central banks. Individuals may
also participate in the foreign exchange market.
- Commercial banks are at the center of the foreign exchange market because almost
every sizable international transaction involves the debiting and crediting of accounts at
commercial banks in various financial centers. Thus, the vast majority of foreign
exchange transactions involve the exchange of bank deposits denominated in different
currencies.
- Corporations. corporations with operations in several countries frequently make or
receive payments in currencies other than that of the country in which they are
headquartered. Multinational corporations participate in the Foreign exchange market to
facilitate international trade and manage currency risk.
- Nonbank financial institutions in the foreign exchange market are entities that provide
foreign exchange services and products but do not hold a banking license. These
institutions play a crucial role in the forex market by facilitating currency exchange,
providing hedging products, and offering other financial services related to foreign
exchange.
- Central banks. Central banks play a significant role in the foreign exchange market by
implementing monetary policy and intervening in the foreign exchange market to
stabilize their domestic currency.
There are transactions in the Foreign Exchange market, the Spot rates and Forward
rates. Exchange rates governing such “on-the-spot” trading are called spot exchange
rates, and the deal is called a spot transaction. In a spot transaction, the exchange of
currencies takes place immediately. In a forward transaction, two parties agree to
exchange currencies at a future date and at an agreed-upon exchange rate.
Foreign exchange deals sometimes specify a future transaction date—one that may
be 30 days, 90 days, 180 days, or even several years away. The exchange rates
quoted in such transactions are called forward exchange rates.
There is also other transaction, A foreign exchange swap, it is a spot sale of a currency
combined with a forward repurchase of that currency. A currency swap involves the
simultaneous purchase and sale of a specific amount of two different currencies, with
the agreement to reverse the transaction at a later date.

4. What are the factors that affect demand for Foreign Currency Assets? Discuss
each factor. (20 points)

-The demand for a foreign currency bank deposit is influenced by the same
considerations that influence the demand for any other asset. A foreign currency
deposit’s future value depends in turn on two factors: the interest rate it offers and the
expected change in the currency’s exchange rate against other currencies.
-Interest rates can have a significant impact on the demand for foreign currency assets.
When interest rates in a particular country rise, it can make assets denominated in that
currency more attractive to investors. This is because higher interest rates can lead to
higher returns on investments in that currency, which can lead to an increased demand
for that currency. Conversely, when interest rates in a particular country fall, it can make
assets denominated in that currency less attractive to investors. Lower interest rates
can lead to lower returns on investments in that currency, which can lead to a
decreased demand for that currency.
-The expected change in a currency's exchange rate against other currencies can have
a significant impact on demand for Foreign Currency Assets. When the exchange rate
of a currency is expected to strengthen against other currencies, there is likely to be an
increase in demand for that currency as investors and traders seek to take advantage of
potential gains in value. And also, when the exchange rate of a currency is expected to
weaken against other currencies, demand for that currency may decrease as investors
and traders look to minimize potential losses in value.

5. What is Equilibrium Exchange Rate? How can this be achieved? (20 points)

The equilibrium exchange rate is the exchange rate at which the quantity of a currency
demanded is equal to the quantity supplied. Achieving the equilibrium exchange rate
involves ensuring that the exchange rate reflects the true value of a currency, without
being overly influenced by short-term fluctuations or speculative activity. It also requires
a combination of monetary, fiscal, and trade policies, as well as market forces, to
ensure that the supply and demand for a currency are in balance. So, achieving the
equilibrium exchange rate is a complex and dynamic process that involves the
interaction of a variety of economic and market forces.