Question

Suppose that in the United States last season’s hot holiday gift was the iPad (which is made primarily in China) while this season’s big gift is media content for the iPad (which is made in the U.S.). Determine whether there will be an increase, decrease, or no change for each of the following variables compared to last year.

     a. The supply of dollars would decrease  Correctand the demand for dollars would not change  Correct.

     b. The exchange rate between the U.S. dollar and the Chinese yuan would fall  Incorrect, causing the dollar to depreciate  Incorrect.

     c. Net exports for the U.S. would increase  Incorrect.

     d. Net capital outflows for the U.S. would fall  Incorrect.

Answer 1

A) The supply of dollars will decrease because of increase in demand for domestic product by USA citizens. However, demand for USD would not change due to unawareness of foreigners' interest in iPad of local contents vs. ipad of foreign contents.

B) With decrease in supply of USD while the demand for USD remains same, will result in an increase in interest rate. Increase in interest rate will attract foreign (China) capital and the exchange rate between USD and yuan will increase. As a result, value of dollar will increase or, dollar will appreciate.

C) When USD appreciates, US made products become expensive to foreigners because they now have to pay more of their currency in order to get 1 USD. As a result, import demand for US made products will decline in foreign countries. In USA, export will decrease and import will increase(because for USA citizens, foreign goods are cheaper now). This will decrease the net export (export minus import).

D) Net capital outflow is always equal to net export (i.e. NCO=NX), the value of net export is the value of capital spent abroad(outflow).

Net capital outflow = acquisition of foreign assets by domestic residents - acquisition of domestic assets by foreigners

USA's net export declined, and if it's running a trade deficit then it must be financing net purchase of goods and services by selling assests abroad. So, net capital outflow will increase.