How each of the following changes will affect the real exchange rate (the number of US...

How each of the following changes will affect the real exchange rate (the number of US baskets per EU basket of goods/services):

a.The relative demand of U.S. products decreases.

b.The relative demand of U.S. products decrease

Expert Solution

(a) The relative demand of U.S products decreases-

Real exchange rate is the value of one currency in terms of another during the supply of goods and services.
When U.S dollar is depreciated then the real exchange rate also falls. As a result the demand for products decreases sharply.
It will increases the export business for U.S products and reduces the import services.
Exchange rate will fall only when the quantity of dollar supply exceeds the amount of dollars demanded.

(b) The relative demand of U.S products increases-

When the demand for U.S products increases then the value of dollar will get appreciated. Also import business will rise and export of goods will get reduce.
Here the quantity of dollar demanded will be more than the value of supply.
An increase in rate of interest will increase demand for dollar in foreign countries.

Note: both the options given in the question are same. So in the option (b) I am considering demand for U.S products increases.

jeff jeffy answered 1 year ago

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