Question

In: Economics

QUESTION TWO PART A The following two economic events impact on the value of the Australian...

QUESTION TWO

PART A

The following two economic events impact on the value of the Australian dollar in the foreign exchange rate market.

Speculators believe that the price of Australian exported commodities (iron ore, coal) will increase and at the same time Australian households and firms purchase less imports.

REQUIRED:

Explain the effect of the above economic conditions on the demand for and supply of Australian dollars and the change in the value of the Australian dollar (AUD) in the foreign exchange rate market (Note: a diagram is not required for this question).

Solutions

Expert Solution

When speculators believe that price of exports will increase, it means that demand for exportable goods will decrease. So, demand for AUD will decrease, shifting its demand curve leftward, decreasing exchange rate and decreasing quantity of AUD.

At the same time, lower imports will decrease the demand for foreign currency and decrease the supply of AUD (since importers will sell lss AUD for imports payment), shifting its supply curve leftward, increasing exchange rate and decreasing quantity of AUD.

The net effect is a definite increase in quantity of AUD traded.

Net effect on exchange rate is uncertain and has 3 possibilities:

(I) If leftward shift in demand is lower than the leftward shift in supply, exchange rate will increase and AUD will appreciate.

(II) If leftward shift in demand is greater than the leftward shift in supply, exchange rate will decrease and AUD will depreciate.

(I) If leftward shift in demand is equal to the leftward shift in supply, exchange rate will remain the same.

Rahul Sunny answered 7 months ago
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