Question

1. Assume that the China inflation rate becomes high relative to Japan inflation. Other things being equal, how should this affect the (a) China demand for Japanese Yen,

(b) supply of Japanese Yen for sale, and (c) equilibrium value of the Japanese Yen ? Explain and show it graphically also.                                                     (Points:3)

Further, assume China interest rates fall relative to British interest rates. Other things being equal, how should this affect the (a) China demand for British pounds, (b) supply of pounds for sale, and (c) equilibrium value of the pound? Explain and show it graphically                                                                                              

Answer 1

1. As inflation rate has increased in China, this will make cost of chinese goods high in comparision to japanese goods. Therefore due to high cost in local markets chinese consumer will increase demand for imports from japan which will lead to increase in demand of japanese yen.

Also on the other hand, cost of chinese goods become more in japan due to high inflation in china. This will lead to reduction in demand of chinese exports in japan, consequently supply of japanese yen will fall, as china will earn less yen from exports.

Both of these will lead to decrease in exchange rate. (Yuan depreciation)

2.

As inflation rate has increased in China, this will make cost of chinese goods high in comparision to british goods. Therefore due to high cost in local markets chinese consumer will increase demand for imports from britain which will lead to increase in demand of british pound.

Also on the other hand, cost of chinese goods become more in britain due to high inflation in china. This will lead to reduction in demand of chinese exports in britain, consequently supply of pound will fall, as china will earn less pound from exports.

Both of these will lead to decrease in exchange rate (Yuan depreciation)

  

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