Question

Suppose the Americans suddenly develop a strong taste for French cheese.

On the following graph, indicate what happens to the demand for U.S. dollars in the market for foreign-currency exchange as a result of this change in tastes. 

 

This causes the value of dollars in the market for foreign-currency exchange to_______  and the equilibrium quantity of net exports to _______ 

Answer 1

When American develop a strong taste for French cheese, it indicates that demand for French cheese will increase leading to a rise in Imports. Since the currency of France is Euro, imports have to be paid in Euro. Increase in imports therefore results in an increase in the demand for Euro ( foreign currency). On the other hand, demand for US dollar will fall.

Fall in demand for US $ is indicated by a left ward shift in demand curve for dollar.

* First blank - Fall

( Since there is a fall in demand for dollars and a rise in demand for foreign currency value of dollar will fall . Dollar will be subjected to depreciation.

This can be understood with the help of the diagram. Exchange rate determined by the intersection of new demand curve and supply curve lesser than the exchange rate determined by the intersection of initial demand curve and supply curve. It means that value of dollar is less than the Value of Foreign currency . )

2) Second blank - Remains unchanged

( Equilibrium quantity of net exports doesn't change even though there is a fall in demand for dollar. In the diagram, you can see that even after new demand curve intersects the supply curve , Equilibrium quantity of dollars doesn't change. It remains Q. Since equilibrium quantity of dollars doesn't change , Equilibrium quantity of net Exports remains the same.)