Question

Q1.Graph the demand for and supply of Australian dollars for US dollars. Label each axis.

From Australia's perspective, show graphically and explain the effect on the Australian dollar of the following.

Australia’s major trading partners experience higher RGDP and income growth resulting in an increase in the price of Australian exported commodities (e.g. coal, iron-ore).
Additionally:
-   there is increased speculation of the Australian dollar (AUD) based on speculators expectations of its future value.
-   Lower interest rates in Australia decrease Australian financial investment overseas.
                                          

Q2.   Explain the impact/ consequence of the change in the exchange rate in (a) above will have on Australia’s net exports, real GDP and the price level in the future.

Answer 1

Q1).

Consider the following fig shows the “foreign exchange market”. So, here “D1” and “S1” are the “demand for foreign exchange” and “supply of foreign exchange” respectively. So, initial equilibrium exchange rate is given by “e1” the intersection of “S1” and “D1”.

Now, increase in “RGDP” of the trade partner, => export of “Australia” will increase, => the supply of “foreign exchange” will increase from “S1” to “S2”. Now, additionally there is an increase in speculation of the “Australian Dollar”, => that will increase the “demand for foreign exchange”, => the demand curve will shift right to “D2”.

Now, the lower interest rate in Australia decrease the Australian financial investment, => the demand for foreign exchange decreases, => the new demand is “D3” left of “D2”. So, the new equilibrium is given by the intersection between “S2”and “D3”, => here the equilibrium exchange rate will decrease from “e1” to “e2”.

Q2).

So, here we can see that the “exchange rate” will decreases, => “export” will decrease and “import” will increase, => “Net Export” will decrease. So, here as the net export will decrease, => “Aggregate Demand” will also decrease, => the “real income” will decreases.

Now, at the old price there will be an excess “supply” as the “real income” decrease, => price will decrease in order to adjust the overall market. So, the equilibrium price will decrease.