Final answer:
The increased demand and reduced supply of U.S. dollars lead to an appreciation of the currency. This stronger dollar can negatively affect U.S. exports and make foreign investments and travel more expensive for Americans, while benefiting foreign tourists and investors in the U.S.
Step-by-step explanation:
Effect of Exchange Rate Changes on the U.S. Market
When international financial investors demand more U.S. dollars to purchase government bonds, it causes a shift in the foreign exchange market. Specifically, the demand for U.S. dollars (D) rises from D0 to D1, and the supply of U.S. dollars (S) decreases from S0 to S1.
With these shifts, the exchange rate appreciates—meaning that the U.S. dollar strengthens against other currencies such as the euro, moving to 1.05 euros per dollar at the new equilibrium (E1). This change, while keeping the quantity of dollars traded constant in the given example, has wide-reaching implications.
Firstly, a stronger U.S. dollar means that U.S. exports become more expensive to foreign buyers, which can lead to a decrease in exports as U.S. goods become less competitive.
Conversely, it is beneficial for foreign tourists and investors in the U.S. as they get more value for their money. U.S. tourists abroad find the cost of traveling more expensive, and U.S. investors looking to invest in foreign markets may find their investments cost more dollars.
The change can also influence foreign investors considering opportunities in the U.S. economy positively, as they can get more dollars for their investment when the U.S. dollar is stronger.