Question

4. Suppose that Denmark has a large trade surplus with the countries in the Euro Area. Suppose that Denmark takes some steps to allow its currency to appreciate respect to the Euro. What do you expect to happen to the trade balance of Denmark with the Euro countries? The answer should be based on the J-curve.

(a) The trade surplus increases (becomes larger) in both the short run and in the long run. (b) The trade surplus increases (becomes larger) in the short run but declines in the long run (becomes smaller or even a deficit).

(c) The trade surplus decreases (becomes smaller) in the short run but increases in the long run (becomes bigger).

(d) The trade surplus declines (becomes smaller or even a trade deficit) in both the short run and in the long run.

Answer 1

answer is: (b)The trade surplus increases (becomes larger) in the short run but declines in the long run (becomes smaller or even a deficit).

The reason for this is an inverted J curve because as the currency appreciates with respect to other currencies, makes imports cheaper and exports costlier. In the short run, price elasticity of demand is relatively inelsatic therefore the quantity of exports may fall by a small amount but the VALUE OF EXPORTS actually rises and similarly quantity of imports only rises by a small amount altough VALUE OF IMPORTS actually falls which results in a rise in trade surplus. While in the long run, the price elasticity of demand become elastic and thus VALUE OF EXPORTS fall by larger proportions due to exports becoming costlier and VALUE OF IMPORTS rises by a large proportion as imports become cheaper whch results in a decline in trade surplus or eventually a trade deficit in the long run .