Chapter . Chapter 16b (27b)

Step 1

Solved Problems

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You must read each slide, and complete any questions on the slide, in sequence.

Question

Suppose that the United States Federal Reserve raises interest rates, while the Bank of England leaves Britain’s interest rates unchanged.

All else equal, after the rate change we would expect American assets to be jeN2u9ngL4p2R3dYan4XiRnk4rRHzrW3aSwPnt3sAH7dQun93pYwQpIX+TGR8BgkWoCUX4fb59g= to foreign investors.

Since investors seek the highest rate of return, higher interest rates make an investment more attractive.

Step 2

Question

All else equal, after the rate hike we would expect British assets to be kTt7S2QiQfV8MmayxErDHy293elEsYO2YaUQNoza0c67/ndjiDOA2n4JdTAat1zx92+YwpvDS+I= to American investors.

Britain’s rates are now relatively lower compared to America’s. U.S. investors have no incentive to invest overseas.

Step 3

Question

On the following supply-and-demand graph for British pounds, we would expect poundholders to supply hr2ll3RlFPp1NEBX9g90Mbw+9BUNRVWzbHZ4c6vaI1qEAFOU British pounds in the foreign exchange markets (versus the dollar) after the rate increase.

The graph shows the demand and supply curves. The horizontal axis is labeled Q of pounds, and the vertical axis is labeled E, or the exchange rate of dollars to pounds. The supply curve is an upward sloping line labeled S. The demand curve is a downward sloping line that intersects thesupply curve approximately in the center.

Since U.S. assets are now more attractive, British investors will offer more pounds as they invest overseas.

Step 4

Question

We would expect dollar holders to demand vIWcHZf4I8r0OkPk6Zhupwt4n54X4rKvmEizVnVbHcXn+LkT British pounds in the foreign exchange markets after the rate increase.

Since Americans will want to keep their money at home, they will not want to purchase as many pounds.

Step 5

Question

As a result, demand (D) OJQdRgkANwRYxwGNBX9Chly5osmcP5L9V9CuDs3uqkxke0kRW4gpEV/rprc= and supply (S) WCk4TGxlDOc/ABr1NIkSCdxanJhklEf3QYcx3j8NynjhJGt70ljcofrkmt4=.

U.S. investors want fewer pounds and British investors want more dollars.

Step 6

Question

The pound will HKQFjod+tBrUAjahsQkZpRklSEXldRyLtTFpzjdspE0Fta8++HC5WeRX84CbrD0n, while the dollar will 8wv1vc4d4cXwXk1f8G+jzNj+A/QFaYjD0PcFqi7wysLqxOM/HwjxvW9f8NE0233E.

The supply and demand shifts combine to result in a lower value of the pound. If a currency is desired less, it should depreciate. At the same time, the dollar is more desired, and as a result it appreciates.

Step 7

Question

This pound depreciation will cause British imports from the U.S. PW8DSqWUF1L/S/9RipEbt5gIjmMbTz1WTWW2PCyVX1xgtHJNfMkn4cKH9Ys=, British exports to the U.S. GtLRpOcGnRSb1CrQAGVWBr9UoNKGPaQwKRXlIK3CNvHLgjHndkZ+tXfjCkc=, and net British exports (X – M) jN5PbS4W/M6dsB01Lrbvv663mKzHFIY+VvkpD2eJSz6t4iwRyPX+z43Ff8g=.

A weaker currency makes exports cheaper and imports more expensive. Both these effects combined, (X – M) must therefore increase.

Step 8

Question

The graph shows the aggregate supply-aggregate demand curve. The horizontal axis is labeled Aggregate Output, and the vertical axis is labeled Aggregate Price Level. The short-run aggregate supply curve is an upward sloping line labeled SRAS. The aggregate demand curve, labeled AD, is a downward sloping line that intersects the SRAS curve approximately in the center.

On the short-run AS-AD graph for Britain, this change in net exports is represented by a C56YR6Osjw7kNt1wEMLmcOdNXAQUt6tT shift in the 4MXSZRgPBzJ25v0bDk28QmvBp08VnFJw4TQzJoFQwRkM/D7UfkctqA== curve.

Since AD = C + I + G + (X – M), an increase in net exports shifts AD to the right.

Step 9

Question

After this shift, the British price level AUOefvMc1ESKXRP3f93gBedGzNTwQDGB1tDzcCSn/jG16bUgjI1M8g==, while British GDP AUOefvMc1ESKXRP3f93gBedGzNTwQDGB1tDzcCSn/jG16bUgjI1M8g==.

The higher import prices increase aggregate demand, which in turn results in increased GDP and price levels.