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.
(a) American cars become suddenly more popular abroad:
- Demand curve for dollars would shift to the right.
- The determinant of the change is an increase in foreign demand for American cars.
- The inflow effect on the balance of payments would be a capital inflow in the export account.
- The equilibrium exchange rate for the value of the dollar would appreciate.
(b) Inflation rates in the United States accelerate:
- Supply curve for dollars would shift to the right.
- The determinant of the change is increased inflation rates.
- The outflow effect on the balance of payments would be a current account outflow due to higher import prices.
- The equilibrium exchange rate for the value of the dollar would depreciate.
(c) The United States falls into a depression:
- Demand curve for dollars would shift to the left.
- The determinant of the change is decreased economic activity.
- The outflow effect on the balance of payments would be a current account outflow as imports decrease.
- The equilibrium exchange rate for the value of the dollar would depreciate.
(d) Interest rates in the United States drop:
- Demand curve for dollars would shift to the right.
- The determinant of the change is decreased interest rates.
- The inflow effect on the balance of payments would be a capital inflow in the financial account.
- The equilibrium exchange rate for the value of the dollar would appreciate.
(e) The United States suddenly experiences rapid increases in productivity:
- Supply curve for dollars would shift to the right.
- The determinant of the change is increased productivity.
- The outflow effect on the balance of payments would be a current account outflow due to increased imports.
- The equilibrium exchange rate for the value of the dollar would depreciate.
(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 would shift to the right.
- The determinant of the change is increased demand for gold.
- The outflow effect on the balance of payments would be a current account outflow as dollars are used to purchase gold.
- The equilibrium exchange rate for the value of the dollar would depreciate.
(g) War is declared in the Middle East:
- Demand curve for dollars would shift to the left.
- The determinant of the change is increased geopolitical uncertainty.
- The outflow effect on the balance of payments would be a current account outflow as imports increase and capital outflow as investors seek safer assets.
- The equilibrium exchange rate for the value of the dollar would depreciate.
(h) The stock markets in the United States suddenly collapse:
- Demand curve for dollars would shift to the left.
- The determinant of the change is decreased investor confidence.
- The outflow effect on the balance of payments would be a capital outflow in the financial account as investors move their investments elsewhere.
- The equilibrium exchange rate for the value of the dollar would depreciate.
To analyze each event and its impact on the demand or supply curve for dollars, the direction of the shift, the determinant of the change, the balance of payments effect, and the resulting movement of the equilibrium exchange rate, we can follow these steps:
(a) American cars become suddenly more popular abroad:
- Demand curve for dollars shifts: Increases.
- Direction of shift: Rightward.
- Determinant of the change: Increase in American car popularity.
- Balance of payments effect: Inflow effect on the balance of payments, specifically the current account (trade balance).
- Resulting movement of the equilibrium exchange rate: Appreciation of the value of the dollar.
(b) Inflation rates in the United States accelerate:
- Supply curve for dollars shifts: Decreases.
- Direction of shift: Leftward.
- Determinant of the change: Increase in inflation rates.
- Balance of payments effect: Outflow effect on the balance of payments, specifically the current account (higher import prices).
- Resulting movement of the equilibrium exchange rate: Depreciation of the value of the dollar.
(c) The United States falls into a depression:
- Demand curve for dollars shifts: Decreases.
- Direction of shift: Leftward.
- Determinant of the change: Occurrence of a depression in the United States.
- Balance of payments effect: Outflow effect on the balance of payments, specifically the capital account (capital flight).
- Resulting movement of the equilibrium exchange rate: Depreciation of the value of the dollar.
(d) Interest rates in the United States drop:
- Demand curve for dollars shifts: Decreases.
- Direction of shift: Leftward.
- Determinant of the change: Decrease in interest rates.
- Balance of payments effect: Outflow effect on the balance of payments, specifically the financial account.
- Resulting movement of the equilibrium exchange rate: Depreciation of the value of the dollar.
(e) The United States suddenly experiences rapid increases in productivity:
- Demand curve for dollars shifts: Increases.
- Direction of shift: Rightward.
- Determinant of the change: Increase in productivity.
- Balance of payments effect: Inflow effect on the balance of payments, specifically the current account (increase in exports).
- Resulting movement of the equilibrium exchange rate: Appreciation of the value of the dollar.
(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 shifts: Decreases.
- Direction of shift: Leftward.
- Determinant of the change: Increase in demand for gold.
- Balance of payments effect: Outflow effect on the balance of payments, specifically the financial account.
- Resulting movement of the equilibrium exchange rate: Depreciation of the value of the dollar.
(g) War is declared in the Middle East:
- Demand curve for dollars shifts: Decreases.
- Direction of shift: Leftward.
- Determinant of the change: Outbreak of war.
- Balance of payments effect: Outflow effect on the balance of payments, specifically the capital account (capital flight).
- Resulting movement of the equilibrium exchange rate: Depreciation of the value of the dollar.
(h) The stock markets in the United States suddenly collapse:
- Demand curve for dollars shifts: Decreases.
- Direction of shift: Leftward.
- Determinant of the change: Stock market collapse.
- Balance of payments effect: Outflow effect on the balance of payments, specifically the financial account.
- Resulting movement of the equilibrium exchange rate: Depreciation of the value of the dollar.