Question

Suppose that cardamom buns(kardemummabullar) are an important export of Sweden, and Germany isa major importer of Swedish cardamom buns.

a. Draw the foreign exchange market of Euros for Swedish kronor. Label the current exchange rateE0.

b. If Germans start eating fewer sweets, show the effect on the foreign exchange market. Label any changes in curve and/or the exchange rate with “1” subscripts. Has the Swedish krona appreciated or depreciated in value against the Euro?

c. Show how this change in the exchange rate would affect the price level and output in Sweden in the short run.

Answer 1

In the given scenario, cardamom buns are an important export of Sweden. Germany is a major importer of Swedish cardamom buns.

Thus, the exchange rate will be determined by the demand and supply forces that affect both the currencies. In the market for Kronor (in terms of Euros), the demand and supply of Kronor will be analyzed (a similar analysis can also be done for the market for Euros).

The exchange rate is denoted in terms of Euros per Krona.

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a. The market of Euros for Kronor is shown below:

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b. The demand for Swedish sweets will fall, thus the demand curve of Krona will shift to the left. Exports from Sweden will fall.

The Krona will depreciate in value against the Euro.

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c. Due to the lack of demand of Swedish sweets, output level will also fall in Sweden.

Exports are an important component of AD, as AD = C + I + G + NX

As NX falls, AD will fall, and the price level will also fall.