Question

In: Finance

Assume that there are exactly two countries: The United States and Australia. Also assume that these...

Assume that there are exactly two countries: The United States and Australia. Also assume that these countries’ economies are closed (i.e. they do not trade or otherwise interact with each other) with one notable exception: The U.S. exports plastic to Australia, and Australia exports iron ore to the U.S. For this question, I will abbreviate the currency of the U.S. as USD and that of Australia as AUD.

a.Suppose that the U.S. imports 100,000 tons of iron at a price of 60 AUD per ton and exports 100,000 tons of plastic at a price of 55 USD per ton. If the exchange rate is 1 AUD = 1 USD, what is the U.S. trade balance in USD?

b.Suppose that the exchange rate changes to 1.1 USD = 1 AUD, and that prices in local currencies remain constant. What is the new price of iron in USD? What is the new price of plastic in AUD?

c.Suppose that the businesses that have made the orders leading to these import and export quantities are all locked in – meaning they are contractually obligated to complete the trade. If the exchange rate changes as in part (b), what will be the trade balance of the United States in USD?

d.In the future, businesses will make different purchasing decisions. In reaction to this change in the exchange rate: What will happen to the quantity of iron demanded by the U.S? What will happen to the quantity of plastic demanded by Australia?

e.Compared to your answer in (c), what will happen to the trade balance of the U.S. under the new quantities described in (d)?f.Graph a curve that shows the general shape of what will happened to the trade balance over time. Your x-axis should be time, your y-axis should be $.

Expert Solution

a. TRADE BALANCE is the difference between the country's total exports value and total imports value within a specified time period. A negative trade balance shows a TRADE DEFICIT. A positive trade balance shows a TRADE SURPLUS.

EXCHANGE RATE : 1 AUD = 1 USD

US : IMPORT VOLUME = 100,000 TONS IRON ORE IMPORT RATE = 60 AUD per ton = 60 USD per ton

TOTAL IMPORTS VALUE = IMPORT VOLUME * IMPORT RATE = 100,000 * 60 = 60,00,000 USD.

EXPORT VOLUME = 100,000 TONS PLASTIC EXPORT RATE = 55 USD per ton

TOTAL EXPORTS VALUE = EXPORT VOLUME * EXPORT RATE = 100,000 * 55 = 55,00,000 USD.

US TRADE BALANCE IN USD = TOTAL EXPORTS VALUE - TOTAL IMPORTS VALUE = 55,00,000 - 60,00,000 = -5,00,000 USD

b. NEW EXCHANGE RATE : 1.1 USD = 1 AUD THEREFORE 1 USD = 1/1.1 AUD = 0.909090 AUD

NEW PRICE OF IRON IN USD : RATE IN AUD * EXCHANGE RATE = 60 * 1.1 = 66 USD PER TON.

NEW PRICE OF PLASTIC IN AUD : RATE IN USD * EXCHANGE RATE = 55 * 0.909090= 49.9999= 50 AUD PER TON

c. NEW TRADE BALANCE OF US IN USD :

TOTAL EXPORTS VALUE = EXPORT VOLUME * EXPORT RATE = 100,000 * 55 = 55,00,000 USD

TOTAL IMPORTS VALUE = IMPORT VOLUME * IMPORT RATE = 100,000 * 66 = 66,00,000 USD.

US TRADE BALANCE IN USD = TOTAL EXPORTS VALUE - TOTAL IMPORTS VALUE = 55,00,000 - 66,00,000 = -11,00,000 USD

d.` USD HAS DEPRECIATED FROM 1 USD = 1 AUD TO 1.1 USD = 1 AUD .

PRICE OF IMPORTED IRON HAS RISEN FROM 60 USD TO 66 USD .

THEREFORE, DEMAND OF IRON FROM AUSTRALIA WILL DECREASE. QUANTITY IMPORTED BY US FROM AUSTRALIA WILL DECREASE.

AUD HAS APPRECIATED FROM 1 AUD = 1 USD TO 1 AUD = 1.1 USD

PRICE OF IMPORTED PLASTIC HAS DROPPED FROM 55 AUD TO 50 AUD .

THEREFORE, DEMAND OF PLASTIC FROM US WILL INCREASE. QUANTITY IMPORTED BY AUSTRALIA FROM US WILL INCREASE .

jeff jeffy answered 1 year ago

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