Question

2. What would you expect each of the following developments to do to the price of dollars in euros? a. European investors lose confidence in American assets and decide to buy fewer American stocks and bonds. b. The European Union removes its existing tariffs on goods from the United States. c. Inflation is higher in the United States than in Europe. Please explain parc c with a graph. This question was answered previously on this websit but it was incorrect so do not post the same answer.

Answer 1

a. As European investors lose confidence in American assets then this will mean that they will invest less in US stocks and bonds. This will cause the demand for US dollars to fall and so the price of dollars to euros will decline. The dollar will depreciate.

b. This will mean that with the removal of the tariff US goods will appear less expensive at the time of importing to those in the European Union. This will cause an increase in the demand for US goods and so the demand for dollars will also increase. This will cause the dollar to appreciate.

c. If inflation is higher in the United States then this will mean that in US dollar terms US goods will appear more expensive to those abroad. This will mean that foreigners will demand less US goods. The price of US goods in dollar terms will then fall. The currency will thus depreciate. The AD curve will thus shift leftwards and so prices fall and output falls over time.