. (TCO E and I) Let the exchange rate be defined as the number of dollars per Ja
ID: 1091226 • Letter: #
Question
. (TCO E and I) Let the exchange rate be defined as the number of dollars per Japanese yen. Assume that there is a decrease in U.S. interest rates relative to that of Japan.
(a.) (10 points) Would this event cause the demand for the dollar to increase or decrease relative to the demand for the yen? Why?
(b.) (10 points) Has the dollar appreciated or depreciated in value relative to the yen?
(c.) (10 points) Does this change in the value of the dollar make imports cheaper or more expensive for Americans? Are American exports cheaper or more expensive for importers of U.S. goods in Japan? Illustrate by showing the price of a U.S. e-reader in Japan before and after the change in the exchange rate.
(d.) (10 points) If you had a business exporting goods to Japan, and U.S. interest rates fell as they have in this example, would you plan to expand production or cut back? Why? (Points : 40)
Explanation / Answer
a. If there is a decrease in US interest rate relative to Japan, there will be inflow of dollars into Japan to take an advantage of the higher interest rates prevailing there. This will result in an increased supply of dollars and an increased demand for conversion to Yen. Thus, dollar demand will decrease and yen demand will increase.
b. As the dollar demand decreases, its value will depreciate with respect to Yen
c. As dollar depreciates, it will cost more dollars to import. The exports will become cheaper.
Lets say 1$ = 100 Yen earlier and now it depreciates to 99 Yen. (i.e Yen appreciates)
Say an e-reader of 10,000 Yen was imported. Earlier it would have cost 10000/100 = $100 in US. Now it will cost 10000/99 = $101.01. Thus value of imports go up.
Similarly, say if US exported goods worth $100 to Japan. In Yen, it would have earlier cost 10,000 Yen but now it costs 9,900 Yen. Thus, the exports have become cheaper.
d. Business exporting goods to Japan from US will be in a good position as their goods will become cheaper for the final consumer in Japan as seen in the example in c above. Thus, I would plan to expand production in US to take advantage of the falling interest rate in US.
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