For each of the following possible events, indicate whether the demand or supply curve for dollars would shift, the direction of the shift, the determinant of the change, the inflow or outflow effect on the balance of payments (and the specific account that would be affected), and the resulting movement of the equilibrium exchange rate for the value of the dollar. (a) American cars become suddenly more popular abroad. (b) Inflation rates in the United States accelerate. (c) The United States falls into a depression. (d) Interest rates in the United States drop. (e) The United States suddenly experiences rapid increases in productivity. ( f ) Anticipating a return to the gold standard, Americans suddenly rush to buy gold from the two big producers, South Africa and the Soviet Union. (g) War is declared in the Middle East. (h) The stock markets in the United States suddenly collapse.
To analyze each event and determine its impact on the demand or supply curve for dollars, the direction of the shift, the determinant of change, the balance of payments effect, and the resulting movement of the equilibrium exchange rate, we need to apply the principles of macroeconomics and international finance.
(a) American cars become suddenly more popular abroad:
- Demand curve for dollars: The demand for dollars would increase since more foreign buyers want to purchase American cars.
- Direction of the shift: The demand curve for dollars would shift to the right.
- Determinant of the change: The determinant of this change is an increase in foreign demand for American cars.
- Balance of payments effect: There would be an inflow on the balance of payments in the current account since exporting cars generates revenue.
- Resulting movement in equilibrium exchange rate: The value of the dollar would increase because increased demand for dollars would lead to its appreciation.
(b) Inflation rates in the United States accelerate:
- Supply curve for dollars: The supply of dollars would increase as inflation erodes the value of the currency.
- Direction of the shift: The supply curve for dollars would shift to the right.
- Determinant of the change: The determinant of this change is inflation in the United States.
- Balance of payments effect: There would be an outflow on the balance of payments in the current account because domestic goods and services become relatively more expensive.
- Resulting movement in equilibrium exchange rate: The value of the dollar would decrease as the increased supply of dollars leads to its depreciation.
(c) The United States falls into a depression:
- Demand curve for dollars: The demand for dollars would decrease as economic activity slows down during a depression.
- Direction of the shift: The demand curve for dollars would shift to the left.
- Determinant of the change: The determinant of this change is a decrease in economic activity in the United States.
- Balance of payments effect: There would be an outflow on the balance of payments in the current account since there is reduced ability to import.
- Resulting movement in equilibrium exchange rate: The value of the dollar would decrease as decreased demand for dollars leads to its depreciation.
(d) Interest rates in the United States drop:
- Demand curve for dollars: The demand for dollars would decrease as lower interest rates make U.S. investments less attractive to foreign investors.
- Direction of the shift: The demand curve for dollars would shift to the left.
- Determinant of the change: The determinant of this change is a decrease in U.S. interest rates.
- Balance of payments effect: There would be an outflow on the balance of payments in the financial account as capital flows out of the country seeking higher returns elsewhere.
- Resulting movement in equilibrium exchange rate: The value of the dollar would decrease as decreased demand for dollars leads to its depreciation.
(e) The United States suddenly experiences rapid increases in productivity:
- Supply curve for dollars: The supply of dollars would increase as increased productivity leads to higher production and export of goods and services.
- Direction of the shift: The supply curve for dollars would shift to the right.
- Determinant of the change: The determinant of this change is an increase in U.S. productivity.
- Balance of payments effect: There would be an inflow on the balance of payments in the current account as U.S. exports increase.
- Resulting movement in equilibrium exchange rate: The value of the dollar would increase as increased supply of dollars leads to its appreciation.
(f) Anticipating a return to the gold standard, Americans suddenly rush to buy gold from South Africa and the Soviet Union:
- Demand curve for dollars: The demand for dollars would increase as Americans need to exchange their dollars for the currencies of South Africa and the Soviet Union to buy gold.
- Direction of the shift: The demand curve for dollars would shift to the right.
- Determinant of the change: The determinant of this change is an increase in demand for currencies of South Africa and the Soviet Union.
- Balance of payments effect: There would be an outflow on the balance of payments in the current account as Americans import gold.
- Resulting movement in equilibrium exchange rate: The value of the dollar would decrease as increased demand for currencies of other countries leads to the depreciation of the dollar.
(g) War is declared in the Middle East:
- Demand curve for dollars: The demand for dollars would decrease as uncertainty and geopolitical risks increase.
- Direction of the shift: The demand curve for dollars would shift to the left.
- Determinant of the change: The determinant of this change is the declaration of war and associated risks.
- Balance of payments effect: There could be an outflow on the balance of payments in the financial account as investors seek safer assets outside the United States.
- Resulting movement in equilibrium exchange rate: The value of the dollar would decrease as decreased demand for dollars leads to its depreciation.
(h) The stock markets in the United States suddenly collapse:
- Demand curve for dollars: The demand for dollars would decrease due to investor sentiment and a flight to safety.
- Direction of the shift: The demand curve for dollars would shift to the left.
- Determinant of the change: The determinant of this change is the stock market collapse.
- Balance of payments effect: There could be an outflow in the financial account as investors seek safer assets outside the United States.
- Resulting movement in equilibrium exchange rate: The value of the dollar would decrease as decreased demand for dollars leads to its depreciation.
By considering these factors and analyzing the impact of the given events, we can understand how the demand and supply curves for dollars would shift, the determinants of change, the balance of payments effects, and the resulting movement of the equilibrium exchange rate.