Question

4). Using IS-LM, what happens to C, I, G, NX, AD, and r if the value of the dollar increases? What happens if US prices increase faster than foreign prices? (please graph)

Answer 1

Ans. If value if dollar decreases, the exports become cheaper and imports become expensive leading to a decrease in net exports causing rightward shift in IS from IS to IS’. This leads to increase in money demand and increase in interest rate which increases cost of borrowing and leads to decrease in investment and consumption leading to shift in IS curve leftwards from IS’ to IS”. Leading to fall in output and decrease in interest rate to r”.

Increase in US prices faster than other countries leads to depreciation of US dollar in accordance with purchasing power parity theory. Then this decrease in value of dollar affects other variables as explained before.

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