Question

Using your AA-DD diagram, graphically illustrate the effect of an decrease in taxes in the U.S. on the value of the Kenyan Shilling against the US dollar (Kenya is the home country). (5 points)

Answer 1

When the tax rate falls in the USA, there will be a rise in the disposable income. The rise in the disposable income will generate the demand for the import. Thus demand for foreign currency shall rise and economy will see the decrease in the value of currency.

Here the dollar will fall while the value of Kenyan currency will appreciate.

Following is the diagram:

in the above diagram, the demand for foreign currency shifts to right thereby leading to depreciation of currency from the e to e1