Question

Assuming market-determined exchange rates, use the supply and demand schedules for pounds to analyze the effect on each exchange rate (dollars per pound) between the U.S. $ and the British pound under each of the following circumstances. Make sure to tell me what happened to the value of the dollar and the exchange rate (and use graphs for questions 16-19 as well)! State whether the dollar appreciated or depreciated and if exchage rate increased or decreased.

18.       The United States unilaterally reduces tariffs on British products.

19.       Fears of terrorism reduce U.S. tourism in Britain.

Answer 1

The first graph answers to question 18. The reduction in tariffs leads to increase in demand for British products, which in turn leads to increase in demand for Pound. This is depicted by the rightward shift of the demand curve(dotted line). This leads to increase in the equilibrium level of exchange rates.

The second graph answers to question 19. The fear of terrorism leads to reduced number of tourist going to Britain. This leads to a reduction in the demand for pounds, thereby leading to a leftward shift of demand curve(depicted by the dotted line). This leads to a reduction in the equilibrium level of exchange rate.