Question

•U.S. produced John Deere tractor, price $25,000 in t-1 and t-2.

•Italian produced designer shoes, price €350 in t-1 and t-2.

•Dollars per Euro:

•If in t-1 $1.0741: €1 then $1 = € 1/1.0741 In t1, $1 = € 0.931012    

•t-2 $1.1385: €1                                                In t2, $1 = € 0.8783487

1.What is the Euro price of the tractor in t-1?

In t-2?

1.What is the U.S. dollar price of the Italian shoes in t-1?

In t-2?

1.Draw a demand curve for U.S. tractors illustrating the effect of the change in exchange rates. Only draw the demand curve.

2.Draw a demand curve for Italian shoes illustrating the effect of the change in exchange rates. Only draw the demand curve.

3.All else remaining equal, what will happen to Italian GDP?* Why?

4.All else remaining equal, what will happen to U.S. GDP?* Why?

Answer 1

Solution

Price of tractor (in USD) in t-1 is : $25,000 ; Exchange rate : $1 =0.931012 Euross

=> Price of Tractor in Euros in t-1 is : 23,275.30 Euros. and

in t-2 = 25,000 * € 0.8783487 => 21,958.7175 Euros

What is the U.S. dollar price of the Italian shoes in t-1 and In t-2

In t-1 , 350 Euros will be equal to (350 / 0.931012) ==> 375.9350 USD

In t-2 , 350 Euros will be equal to (350 /0.8783487) ==> 398.4750 USD

1. and 2.

3.All else remaining same, since the Euro appreciates relative to the US Dollar,the exports of Italy become costlier for the US so,they import less.GDP of Italy reduces because GDP = C+I+G+(X-M) where X denotes the Exports to other countries.

4.All else remaining same,the exports of the US to Italy increase as they become cheaper for Italians.So the GDP of the US will increase.

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