Question

Suppose a politician says the following: Dollar used to be strong. That is no longer the case. If I am elected, I will make sure that the dollar is the strongest currency in the world. Ceteris paribus, if the dollar rises and becomes the strongest currency, will that have a positive or negative effect on the economy? Using the theory of aggregate demand and supply, defend your position.

Answer 1

Rise in dollar would mean that imports will be less expensive. So goods manufactured in the US will be expensive to be sold in the foreign markets. Less expensive imports (cheaper) means that when you pay $1 you will get a commodity for 52 inspite of 45($1) that was the earlier rate. Therefore, Aggregate demand would fall.

This would have negative impact in the economy because aggeregate demand falls if value of currency rises to a certain level. This can be shown with the help of aggregate demand and supply graph.

On X axis real GDP is shown while on Y axis price of exchange rate is shown.

When dollar rises, Aggregate demand curve shifts leftwards leading to fall in real GDP. Initially, Real GDP was Y at P price. When dollar rises, real GDP falls to Y1 at price P1.

So this graph depicts negative impact revealing fall in real GDP as a result of fall in aggregate demand other things remaining constant that is, do not change(ceterus paribus).