Page 471 - Krugmans Economics for AP Text Book_Neat

fyi

Low -Cost America
Does the exchange rate matter for business de- Net exports
cisions? And how. Consider what European auto (billions of
2000 dollars)
manufacturers were doing in 2008. One report
$100
from the University of Iowa summarized the sit-
0
uation as follows:
–100
While luxury German carmakers BMW and
–200
Mercedes have maintained plants in the Ameri-
–300
can South since the 1990s, BMW aims to ex-
–400
pand U.S. manufacturing in South Carolina by
–500
50% during the next five years. Volvo of Sweden
–600
is in negotiations to build a plant in New Mexico.
Analysts at Italian carmaker Fiat determined –700
that it needs to build a North American factory
to profit from the upcoming re -launch of its Alfa 1947 1960 1970 1980 1990 2000 2008
Romeo model. Tennessee recently closed a deal Year
with Volkswagen to build a $1 billion factory by
offering $577 million in incentives. change rate made it substantially cheaper for real net exports of goods and services: exports
Why were European automakers flocking to European car manufacturers to produce in minus imports, both measured in 2000 dollars.
America? To some extent because they were the United States than at home—especially if As you can see, this balance, after a long slide,
being offered special incentives, as the case of the cars were intended for the U.S. market. turned sharply upward in 2006.
Volkswagen in Tennessee illustrates. But the big Automobile manufacturing wasn’t the only The positive effects of the weak dollar on net
factor was the exchange rate. In the early 2000s, U.S. industry benefiting from the weak dollar; exports were good news for the U.S. economy.
one euro was, on average, worth less than a dol- across the board, U.S. exports surged after The collapse of the housing bubble after 2006
lar; by the summer of 2008 the exchange rate 2006 while import growth fell off. The figure was a big drag on aggregate demand; rising net
was around €1 = $1.50. This change in the ex- shows one measure of U.S. trade performance, exports were a welcome offsetting boost.

Module 42 AP Review

Solutions appear at the back of the book.
Check Your Understanding

1. Suppose Mexico discovers huge reserves of oil and starts 2. Suppose a basket of goods and services that costs $100 in the
exporting oil to the United States. Describe how this would United States costs 800 pesos in Mexico and the current
affect the following: nominal exchange rate is 10 pesos per U.S. dollar. Over the next
a. the nominal peso–U.S. dollar exchange rate five years, the cost of that market basket rises to $120 in the
b. Mexican exports of other goods and services United States and to 1,200 pesos in Mexico, although the
c. Mexican imports of goods and services nominal exchange rate remains at 10 pesos per U.S. dollar.
Calculate the following:
a. the real exchange rate now and five years from now, if
today’s price index in both countries is 100
b. purchasing power parity today and five years from now

module 42 The Foreign Exchange Market 429