ANSWERS, SOLUTIONS, AND EXERCISES
PROBLEM SET
1. a. The demand for French and Italian wine, and therefore for the euro, would
increase, and consequently the dollar would depreciate.
2. a. Setting the quantity of pounds demanded equal to the quantity supplied, we have
b. After the U.S. government intervenes, the demand for pounds equation becomes
12 – 2e. Resolving for equilibrium, the exchange rate climbs to 1.6 dollars per
3. a. Setting the quantity of pesos demanded equal to the quantity supplied, we have
b. If the Philippine central bank wants to fix the exchange rate at 50 pesos per dollar
it should buy pesos. To find how many pesos per month it should buy, remember
that 1/50 = 0.02 dollars per peso. Insert this price into our equations, then set the
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313 Instructor’s Manual for Economics: Principles and Applications, 6e
4.
Dollars
per
Peso
Quantity
of pesos
e
e
S
pesos
S
pesos
D
pesos
D
pesos
a. As the U.S. interest rate rises, causing a and I to fall, U.S. GDP decreases. The
interest rate increase also makes U.S. assets more attractive to Americans and to
Mexicans. This, combined with the fall in U.S. GDP, causes the demand curve for
b. The U.S. dollar appreciation causes net exports to fall, further shrinking
c. If the Mexican central bank raised its interest rates just as much as the United
States, then the dollar would not appreciate as much. (It might still appreciate
Chapter 29 Exchange Rates and Macroeconomic Policy 314
5. a.
b. A fixed rate of 1.41 dinars per dollar is the equivalent of $0.71 per dinar. Since this
c. As long as Jordan is not concerned about money supply growth and its effects on
d.
e. The end result is that Jordan’s central bank must sell even more dinars to maintain
the fixed rate.
315 Instructor’s Manual for Economics: Principles and Applications, 6e
6. a.
b. A fixed rate of 1.41 dinars per dollar is the equivalent of $0.71 per dinar. Since this
c. Jordan would eventually run out of foreign reserves, and so could not buy dinars
forever.
d.
e. The end result is that Jordan’s central bank must buy even more dinars to maintain
the fixed rate.
Chapter 29 Exchange Rates and Macroeconomic Policy 316
7. a. An overvalued currency makes imports cheaper and exports more expensive. This
benefits firms and households that use imports, since they pay lower prices for the
b. An undervalued currency makes imports expensive and exports cheap. This
benefits exporters, since foreigners will buy more of the country’s goods than they
8. Since Country B has the higher inflation rate, its relative price level is rising. As its
basket of goods becomes relatively more expensive, only a depreciation of its currency
9. a. If the euro and the U.S. dollar are allowed to float freely, the equilibrium exchange
b.
c. The demand curve shift from D1 to D2 creates an excess demand for euros equal to
700 million euros at the original exchange rate of $0.90 per euro. The European
317 Instructor’s Manual for Economics: Principles and Applications, 6e
10. Since the trade deficit at point B equals 2,000 billion yen, and since the exchange rate
MORE CHALLENGING
11.
Dollars
per
Yen
Quantity
of Yen
e
e
S
2¥
D
=
U.S. Imports
from Japan
S
1¥
=
U.S. Exports
to Japan
A
B
a. With no trading in assets, the quantity of yen demanded is equal to U.S. imports
from Japan, measured in yen. The quantity of yen supplied is equal to U.S. exports
b. If the Japanese reduce trade barriers, U.S. firms would sell more goods to Japan.
As U.S. exports to Japan increased, the supply of yen curve would shift rightward,
and the dollar would appreciate. However, the trade deficit would continue to
c. As long as the United States has a net financial inflow, it will also have a trade
12. a. The rise in China’s price level, assuming no change in the U.S. price level, will
Chapter 29 Exchange Rates and Macroeconomic Policy 318
b. At the same time, the relatively higher price level in China will reduce demand by
c. The combined effect of an increased supply of Yuan and a decreased demand for
d. The falling price of the Yuan will reduce the level of undervaluation of the fixed
EXPERIENTIAL EXERCISE
The latest data on exchange rates appear in the Currency Trading column in the Wall Street
Journal. You can find it in the Money & Investing section. Try tracking a particular currency