Question

Complete the following: Using a supply and demand model in the market for foreign exchange, show how each of the following changes will affect the exchange rate (R) in the market for U.S. dollars.

a. The United States experiences rapid decrease in productivity

b. Return to investments in the United States increase.

c. American computers are less popular abroad.

d. The stock market in the United States recovers from the Great Recession.

e. There is evidence of deflation (decrease in average price level) in United States.

f. There is a bubble in the market for precious metals and the price of gold and silver goes down.

Answer 1

a. When the productivity in the United States decreases, the demand for U.S dollars will decrease. The gaphs below show the market for U.S dollar. Due to decreased productivity the demand curve for dollars will shift to the left. Equilibrium shifts from E to E1. The exchange rate depreciates from R to R1.

b. When returns to investment increase, more people would want to invest in America. The demand curve for dollar shifts rightwards. Exchange rate appreciates .

c. As shown in the figure, this will lead to depreciation of US dollar.

d. When the market recovers from the recession, there will be increased demand for dollars, resulting in appreciation of dollar.