Question

The United States and Canada are trade partners. Each country has a zero current account balance and is operating in long-run equilibrium. Assume that inflationary pressure causes the price level in the United States to rise relative to Canada. (a) How will the change in the price level in the United States affect: · U.S. demand for Canadian goods and services? • net exports of the United States? Explain. (b) Illustrate the impact of the change you identified in part (a) on a fully labeled AD-AS model for the U.S. economy. Use arrows to indicate any changes in AD, real GDP, and price level. (c) Ceteris paribus, will Canada's national income increase, decrease, or remain the same? (d) On side-by-side and fully labeled foreign exchange market graphs, illustrate the impact of the change in relative inflation on supply of the U.S. dollar (USD) and on demand for the Canadian dollar (CAD). Use arrows to indicate the change in the equilibrium exchange rate for each currency. Part 2: Japan and China are trade partners, each with a current account balance of zero. The government of Japan increases taxes for all businesses in Japan. (e) On a fully labeled foreign exchange market graph, illustrate the impact of Japan's policy change on the Japanese yen (JPY) with the price in terms of the Chinese renminbi (RMB). (f) Based on your response to part (e), has the Chinese renminbi appreciated or depreciated? (g) Assume the new exchange rate is 20 yen per 1 renminbi. Calculate the price of yen in terms of renminbi. Part 3: Respond succinctly and precisely to each of the following scenarios. Hint: these are beginning with a currency value change; start from there, and do not consider what caused the change. (h) The European Union and Brazil are trade partners. Brazil's currency, the real, appreciates relative to the European Union's euro. Ceteris paribus, how will this change affect: • Brazil's net exports? Explain. • the capital and financial account of Brazil?

Answer 1

Increased inflation in the U.S. will decrease the demand for Canadian goods and worsen U.S. net exports while causing the USD to depreciate. Canada's national income may decrease, while exchange rate shifts will be reflected in the foreign exchange market graphs for USD and CAD. Japan's tax increase on businesses may lead to yen depreciation and RMB appreciation, and Brazil's real appreciation would decrease its net exports but may attract foreign investment.

Step-by-step explanation:

A rise in the price level in the United States, due to inflationary pressure, affects both U.S. demand for Canadian goods and services as well as U.S. net exports.

An increased price level makes U.S. exports less competitive abroad and imports from Canada more attractive to U.S. consumers, leading to a decrease in U.S. demand for Canadian goods and services and worsening U.S. net exports.

In terms of exchange rates, higher inflation in the U.S. compared to Canada would decrease the demand for U.S. dollars and increase the supply, leading to a depreciation of the U.S. dollar.

This change is represented on an AD-AS model by a movement to the left of the AD curve, indicating a potential decrease in real GDP and an increase in the price level in the domestic economy. However, outputs are dependent on the responsiveness of the aggregate supply.

Considering Canada's perspective ceteris paribus, a decrease in U.S. demand for Canadian goods suggests that Canada's national income might decrease unless compensated by other factors such as increased domestic demand or improved trade with other partners.

In the foreign exchange markets, the supply and demand curves for the respective currencies adjust to reflect these changes, with the supply of USD increasing and the demand for CAD also increasing, thereby affecting exchange rates accordingly.

In the case of Japan increasing taxes for businesses, the Japanese yen would likely depreciate because higher taxes can reduce economic activity, leading to decreased demand for the currency.

This depreciation is shown on a foreign exchange market graph as a shift in demand for the yen to the left. Given the new exchange rate, the Chinese renminbi would appreciate relative to the yen.

If Brazil's currency, the real, appreciates compared to the euro, Brazil's net exports would likely decrease because Brazilian goods and services become more expensive to foreigners. Brazil's capital and financial account might see an inflow as the stronger real attracts foreign investment seeking to benefit from the currency appreciation.

Answer 2

When the price level in the United States rises relative to Canada, it leads to a decrease in U.S. demand for Canadian goods and services and a decrease in net exports. In a fully labeled AD-AS model, the aggregate demand curve shifts to the left, resulting in a decrease in real GDP and an increase in the price level. In a recession in Canada, national income would likely decrease. In the foreign exchange market, an increase in relative inflation in the United States would cause the supply of the USD to increase and the demand for the CAD to decrease, leading to a depreciation of the USD and an appreciation of the CAD.

Step-by-step explanation:

(a) When the price level in the United States rises relative to Canada, it makes U.S. goods and services more expensive for Canadian consumers. As a result, the U.S. demand for Canadian goods and services decreases. This is because the price increase makes U.S. exports relatively less competitive compared to domestic Canadian goods and services. The net exports of the United States will also decrease as a result of the decrease in demand for U.S. goods and services.

(b) In a fully labeled AD-AS model for the U.S. economy, an increase in the price level would cause the aggregate demand (AD) curve to shift to the left. This shift is due to the decrease in demand for U.S. goods and services as a result of the higher prices. The real GDP decreases as a result, while the price level increases.

(c) Ceteris paribus, if there is a recession in Canada, it will likely lead to a decrease in Canadian national income. This is because a recession is typically characterized by a decrease in economic activity, which leads to a decline in income.

(d) On a side-by-side and fully labeled foreign exchange market graph, an increase in relative inflation in the United States will cause the supply of the U.S. dollar (USD) to increase while the demand for the Canadian dollar (CAD) will decrease. As a result, the equilibrium exchange rate will show a depreciation of the USD and an appreciation of the CAD.