Subpart (a):
To show the effect of each event on the current account balance and the exchange rate.
Subpart (a):
Explanation of Solution
The US government cutting tax rate is an expansionary fiscal policy. When the exchange rates are fixed, an expansionary fiscal policy leads to an increase in the income. This would lead to a rise in the
Concept Introduction:
Current account: The current account is the entry of all the transactions of a country's net export, net income on investment, and net transfers as a part of the balance of payment.
Exchange rate: It is the rate at which one currency is exchanged for another currency.
Fixed exchange rate: It is the system of exchange where the exchange rate will be fixed and pre-determined by the central authority. It will be free from the demand and supply of currency in the exchange market.
Floating exchange rate: The floating exchange rate system is a system in which the exchange rate is determined at the equilibrium of the
Subpart (b):
To show the effect of each event on the current account balance and the exchange rate.
Subpart (b):
Explanation of Solution
When the fixed exchange rates prevail, the inflation level in US makes the products less attractive and expensive. This will lead to an increase in the imports and decrease in the exports resulting in a decrease in the current account balance. When the exchange rate floats, inflation would lead to depreciation in the dollar and the current account remains unaffected.
Concept Introduction:
Depreciation of currency: It is the process of decreasing the value of a home currency with regard to another foreign currency in the currency exchange market.
Fixed exchange rate: It is the system of exchange where the exchange rate will be fixed and pre-determined by the central authority. It will be free from the demand and supply of currency in the exchange market.
Floating exchange rate: The floating exchange rate system is a system in which the exchange rate is determined at the equilibrium of the supply and demand for the currency. It will thus change the exchange rate according to the changes in the demand and supply.
Subpart (c):
To show the effect of each event on the current account balance and the exchange rate.
Subpart (c):
Explanation of Solution
When the US adopts an expansionary
Concept Introduction:
Appreciation of currency: It is the process of increasing the value of a home currency with regard to another foreign currency in the currency exchange market.
Depreciation of currency: It is the process of decreasing the value of a home currency with regard to another foreign currency in the currency exchange market.
Fixed exchange rate: It is the system of exchange where the exchange rate will be fixed and pre-determined by the central authority. It will be free from the demand and supply of currency in the exchange market.
Floating exchange rate: The floating exchange rate system is a system in which the exchange rate is determined at the equilibrium of the supply and demand for the currency. It will thus change the exchange rate according to the changes in the demand and supply.
Subpart (d):
To show the effect of each event on the current account balance and the exchange rate.
Subpart (d):
Explanation of Solution
When the consumers favor the domestically produced goods, the demand for imports decreases and this lead to a decrease in the demand for foreign currency. When the exchange rate is fixed, this would lead to an increase in the current account balance and when the exchange rate floats, this would lead to an appreciation of dollar. However, the impact on current account balance remains uncertain.
Concept Introduction:
Appreciation of currency: It is the process of increasing the value of a home currency with regard to another foreign currency in the currency exchange market.
Fixed exchange rate: It is the system of exchange where the exchange rate will be fixed and pre-determined by the central authority. It will be free from the demand and supply of currency in the exchange market.
Floating exchange rate: The floating exchange rate system is a system in which the exchange rate is determined at the equilibrium of the supply and demand for the currency. It will thus change the exchange rate according to the changes in the demand and supply.
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Chapter 19 Solutions
Principles of Macroeconomics, Student Value Edition Plus MyLab Economics with Pearson eText -- Access Card Package (12th Edition)
- Explain why a decline in a country's exchange rate will generally increase the demand for its goods and reduce its demand for foreign goods.arrow_forwardIdentify two factors (or characteristics of economy) that underlie a nation’s decision to adopt a fixed exchange rate or a floating exchange rate.arrow_forwardAnswer the followings: 1. A depreciation of the dollar on the foreign exchange market would result in: A) a decrease in the dollar prices paid by U.S. importers. B) foreign holidays for U.S. residents to be less expensive. C) a decrease in the demand for U.S. exports. D) an increase in the foreign currency prices paid for U.S. exports. 2. The exchange rate for one U.S. dollar is 1.2 Euros and 1.5 British pounds. Exactly six months later, the exchange rate for one U.S. dollar is 0.9 Euro and 1.7 British pounds. We can say: A) the dollar has depreciated relative to both British pounds and Euros. B) the dollar has appreciated relative to both British pounds and Euros. C) the dollar has appreciated relative to Euros and depreciated relative to British pounds. D) the dollar has appreciated relative to British pounds and depreciated relative to Euros. 3. The cost of a trip to New York, US, was $5000. Two weeks later, the US dollar appreciated against the British pound. If the price of the…arrow_forward
- We look at the trade of gas between Russia and the EU and assumes that both areas' supply curves slope upwards and their demand curves slope downwards in the diagram with quantity on the horizontal axis and price on the vertical axis. To make the situation simple, we also initially assume that the exchange rate is constant, and it is 1 (so that we do not need to differentiate between the prices i Russia and the EU). In the autarky equilibria, prices are higher in the EU than in Russia. Unless otherwise specified, there are no trading costs, and the capacity of the pipelines is not binding (ie with free trade the prices are basically the same in the EU and Russia). (a) Draw and show the supply of export goods and the demand for import goods in relation to the two areas' supply and demand curves (three islands next to each other). (b) What happens (to welfare in the two countries and consumer surplus/producer surplus) if the EU stops importing Russian gas? (c) Without Nord Stream 1/2 in…arrow_forwardWith an exchange rate of 0.73 euros for 1 dollar, a US company is able to purchase 100 trucks from Germany. If the exchange rate shifted to 1 euro for 1 dollar, what would happen to the price the US company would pay for trucks? A)The price would go down, because the US dollar has appreciated. B)The price would go up, because the US dollar has depreciated. C)The price would go up, because the US dollar has appreciated. D)The price would go down, because the US dollar has depreciated.arrow_forwardIn 1992, 18.6 million Canadians visited the United States, but only 11.8 million U.S. residents visited Canada. By 2002, roles had been reversed: more U.S. residents visited Canada than vice versa. Why did the tourism reverse direction? Canada didn’t get any warmer from 1992 to 2002 – but it did get cheaper. The reason is a large change in the exchange rate: in 1992 Canadian dollar was worth $0.80, but by 2002 it had fallen in the value by 20% to about $0.65. This means that Canadian goods and services, particularly hotel rooms and meals, were about 20% cheaper for Americans in 2002 compared to 1992. American vacations had become 20% more expensive for Canadians. Canadians responded by vacationing in their own country or in other parts of the world. Foreign travel is an example of a good that has a high price elasticity of demand: elasticity=4.1. One reason is that foreign travel is a luxury good for most people – you may regret not going to Paris this year, but you can live…arrow_forward
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- If a country with floating exchange rates uses an expansionary monetary policy, the domestic interest rate: A) increases, demand for the domestic currency increases, supply of the domestic currency decreases, and the exchange rate increases. B) falls, demand for the domestic currency decreases, supply of the domestic currency increases, and the exchange rate decreases. C) falls, demand for the domestic currency remains unchanged, supply of the domestic currency increases, and the exchange rate decreases. D) falls, demand for the domestic currency decreases, supply of the domestic currency increases, and the effect on the exchange rate is ambiguous.arrow_forwardQ3-1 In a situation of flexible exchange rates, other things equal, a shift of the IS curve to the left will lead to ______ of the country's currency if the BP curve is steeper than the LM curve and will ______ of the country's currency if the LM curve is steeper than the BP curve. Select one: a. an appreciation / also lead to an appreciation b. an appreciation / lead to a depreciation c. a depreciation / lead to an appreciation d. a depreciation / also lead to a depreciationarrow_forwardIn April 2002, the price of a Big Mac in the UK was £1.99. Using data from The Economist's Big Mac Index for April 2002, the following table shows the local currency price of a Big Mac in several countries and the actual exchange rate. At the time, a Big Mac in the United States would have cost you 2.49 pounds. The actual exchange rate between the pound and the euro was £0.69 per British pound. The euro price of a Big Mac in the United States was, therefore, 2.49 British pounds x £0.69 per British pound = £1.71, which is less than you'd have paid in the UK. For the price you paid for a Big Mac in the UK, you could have purchased a Big Mac in the United States and had some change left over for french fries. Big Mac Index: April 2002 Country Local Price Actual Exchange Rate Argentina 2.49 pesos £0.23 per peso Brazil 3.6 reais £0.29 per real United States 2.49 pounds £0.69 per pound Euro zone 2.67 euros £0.62 per euro Poland 5.9 zloty £0.17 per zloty Switzerland 6.3 francs £0.42 per franc…arrow_forward
