Assume the country of Sluban ties its currency (the slu) to the dollar and the exchange...

Assume the country of Sluban ties its currency (the slu) to the dollar and the exchange rate will remain fixed. Sluban has frequent trade with countries in the eurozone and the United States. All traded products can easily be produced by all the countries, and the demand for these products in any country is very sen- sitive to the price because consumers can shift to wherever the products are relatively cheap. Assume that the euro depreciates substantially against the dollar during the next year.

a. What is the likely effect (if any) of the euro’s exchange rate movement on the volume of Sluban’s exports to the eurozone? Explain.

b. What is the likely effect (if any) of the euro’s exchange rate movement on the volume of Sluban’s exports to the United States? Explain.

Expert Solution

a) Sluban has tied its currency to the dollar and the rate will remain fixed, hence it will move with the dollar. So when Euro depreciates against dollar, it will also depreciate against slu. For Sluban, its exports will become less competitive because since Slu has appreciated against the dollar, its exporters to Eurozone will receive less slu for their exports. Hence they will become less competitive as their cash inflow will decrease. This may result in lower investment in new technology and research which will make the exports less competitive futher. Hence the overall effect will be that the tootal volume of exports will decrease.

b) Since the slu is pegged to dollar there will not be any direct effect of the exchange rate movement on volume of trade to US. However since all traded products can easily be produced by all the countries, and the demand for these products in any country is very sensitive to the price because consumers can shift to wherever the products are relatively cheap, therefore Eorozone area will be able to provide the products at a cheaper rate due to their currency depreciating and their exports becoming more competitive. So the exports from Eurozone to US will rise, resulting in decrease in exports from Sluban to US.

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