Question

Supply and Demand

During the American Revolution, Washington’s spies, patriots, thwarted an attempt by the British to destroy the American Economy. The British were attempting to print and flood the markets with Colonial dollars.

Explain with a diagram of supply and demand what would happen to the value of the Colonial dollars if the British would have succeeded and its effect on prices.

Answer 1

Flooding the currency market with Colonial dollars will increase the supply of Colonial dollars, shifting its supply curve rightward. This will result in depreciation of Colonial dollar and and increase in its quantity traded.

In following graph, D0 & S0 are initial demand and supply curves of Colonial dollars, intersecting at equilibrium point A with initial equilibrium exchange rate P0 and initial equilibrium quantity of Colonial dollars Q0. When supply increases, S0 shifts right to S1, intersecting D0 at point B with lower exchange rate P1 and higher quantity of Colonial dollars Q1.