. For each of the following two situations, draw a diagram of the exchange rate market...

. For each of the following two situations, draw a diagram of the exchange rate market for U.S. dollars showing clearly the demand and supply of U.S. dollars in exchange for Japanese yen. Identify the initial equilibrium.

Next illustrate on the diagrams the impact of each of the following events. Then draw a conclusion on the resulting impact on the exchange rate.

(All axes, curves, and points should be clearly labeled to receive full credit)

An increased preference for American goods by Japanese consumers. For example, suppose that American firms come to dominate the video game market, with games that are more exciting and realistic than those produced in Japan. Or, Japanese airlines might find that U.S.-built aircraft are superior to others and decide to expand the number of American-made planes in their fleets.

The interest-rate on one-year Japanese government bonds rises relative to the interest rate on similar one-year U.S. Treasury bills. (4pts)

Solutions

Expert Solution

In both graphs, exchange rate (P) and quantity of dollars (USD) (Q) are shown along vertical and horizontal axis, respectively. D0 and S0 are initial demand and supply of USD, intersecting at point A with initial exchange rate P0 and quantity of USD Q0.

(a)

Increase in Japan's preference for US-made goods will increase Japan’s import demand from US, which will in turn increase the demand for USD.

The demand curve for dollars shifts rightward to D1. Exchange rate will increase and quantity of USD will increase, so USD will appreciate.

In following graph, D0 shifts right to D1, intersecting S0 at point B with higher exchange rate P1 and higher quantity of USD Q1.

(b)

Increase in interest rate in Japan will increase global investment in Japan and decrease global investment in US. Demand for USD will fall, shifting demand curve leftward, lowering exchange rate and increasing quantity of USD. At the same time, supply of USD will increase (because, more Americans sell dollar and buy Yen for investing in Japan), shifting supply curve rightward, lowering exchange rate and decreasing quantity of USD. The net effect is a definite decrease in exchange rate (USD depreciates) and net effect on quantity is indeterminate.

In following graph, D0 shifts left to D1 and S0 shifts right to S1, intersecting at point B with lower exchange rate P1 and new quantity of USD Q1.

Rahul Sunny answered 1 year ago

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