Question

Make two different graphs

Sketch a graph that demonstrates the demand and supply for US dollars against the Canadian dollar. Label the initial equilibrium exchange rate and quantity of dollars.

On the graph, clearly demonstrate (shift the correct curve(s)) what happens to the exchange rate when the US has a higher inflation rate than Canada. Explain why you have drawn the change as you have.

Sketch a graph that demonstrates the demand and supply for the South Korean won against the US dollar. Label the initial equilibrium exchange rate and quantity of won.

On the graph, clearly demonstrate (shift the correct curve(s)) what happens to the exchange rate when strong growth is expected by firms in South Korea. Explain why you have drawn the change as you have.

Answer 1

(a) When US has higher inflation rate that Canada, US-made exportable goods become costlier and Canadian goods become cheaper, therefore US export demand falls and import demand (for Canadian goods) rises, which decreases the demand for US dollars, shifting the US-dollar demand curve leftward, lowering the exchange rate.

In following graph, exchange rate (P) and quantity of US dollars (Q) are measured vertically and horizontally respectively. D0 and S0 are initial demand and supply curve for US dollars, intersecting at point A with initial exchange rate P0 and quantity of US dollars Q0. As demand for US dollars falls, D0 shifts left to D1, intersecting S0 at point B with lower exchange rate P1 and lower quantity of US dollars Q1.

(b) When strong growth is expected in S.Korea, aggregate demand rises faster than aggregate supply in S. Korea, increasing import demand. This increases the demand for US dollars and decreases the demand for S.Korean Won, shifting the demand curve for Won leftward, lowering the exchange rate.

In following graph, exchange rate (P) and quantity of Won (Q) are measured vertically and horizontally respectively. D0 and S0 are initial demand and supply curve for Won, intersecting at point A with initial exchange rate P0 and quantity of Won Q0. As demand for Won falls, D0 shifts left to D1, intersecting S0 at point B with lower exchange rate P1 and lower quantity of Won Q1.