Question

Use the simple exchange-rate model (supply and demand model for foreign exchange market) to answer the following questions.

2.1. Assume an initial equilibrium level for price and quantity in the US versus China exchange rate market. Plot the exchange rate of US dollars per Chinese yuan versus the quantity of Chinese yuans traded. Then graphically simulate the impact of an increase in tariffs imposed by the US on Chinese goods and indicate your forecast for the potential changes in the exchange rate and quantity of Chinese yuans traded.

2.2. Assume an initial equilibrium level for price and quantity in the US versus Mexico exchange rate market. Plot the exchange rate of US dollars per Mexican peso versus the quantity of pesos traded. Then graphically simulate the impact of an increase in Mexico’s productivity relatively to the US, and indicate your forecast for the potential changes in the exchange rate and quantity of pesos traded.

Answer 1

2.1. Increase in tariffs imposed by USA on Chinese goods

Due to the increase in tariffs, Chinese goods will become costlier in USA. The demand for such goods will fall, and imports will fall. This will reduce the demand for yuan.

Due to this, the yuan will depreciate against the USD. The quantity traded of yuan will decrease.

Exchange rate falls from E to E", quantity falls from Q to Q".

------

2.2. Increase in productivity of Mexico

Due to the increase in productivity, output of Mexico will rise. This will lower their prices of exports. This will increase the demand for Mexican goods, and raise exports. This will increase the demand for pesos.

Due to this, the peso will appreciate against the USD. The quantity traded of pesos will rise.

Exchange rate rises from E to E", quantity rises from Q to Q".