Suppose the market for euros is initially in equilibrium at $1.00 per euro and 4
ID: 1210414 • Letter: S
Question
Suppose the market for euros is initially in equilibrium at $1.00 per euro and 4 billion euros, as seen on the graph below. Suppose an economic downturn in the United States leads to a drop in American incomes, causing imports from Europe to decline. The demand for euros shifts to the left, from D1 to D2. Under a system of flexible exchange rates, the dollar will until the foreign exchange market reaches an equilibrium exchange rate of Now suppose that the United States wants to maintain the initial equilibrium exchange rate of $1.00 per euro. Which of the following U.S. government policies would prevent the change in demand for euros from driving the exchange rate to the new equilibrium level? Check all that apply. Reduce income taxes in the United States Place import restrictions on European goods Sell U.S. euro reserves in the foreign exchange market Suppose that the exchange rate between U.S. dollars and Brazilian reais is flexible and is determined by the forces of demand for and supply of the two currencies. Assume also that labor is immobile between the United States and Brazil due to high transportation costs. Which of the following situations is likely to happen as a result of a simultaneous decrease in the demand for U.S. goods and increase in the demand for Brazilian goods? The Brazilian unemployment rate increases, and the country undergoes bad economic times for a sustained period. The U.S. unemployment rate increases, and the country undergoes bad economic times for a sustained period. The U.S. unemployment rate rises at first, but then it drops as U.S. dollars depreciate against Brazilian reais. The U.S. unemployment rate rises at first, but it soon drops as unemployed Americans move to Brazil for employment.Explanation / Answer
Correct Answer:
The Dollar will appreciate
Due to decrease in demand of Euro, Dollar will appreciate with respect to the Euro.
Equilibrium exchange rate of $.75 per euro
A new equilibrium exchange rate is established that $.75 per euro as depicted in the graph.
Reduce income taxes in the United States
Reducing income tax will cause an increase in disposable income. It will compensate the lost income due to the economic downturn. It will help consumers to raise the demand of imported goods from European market that will surge the demand of the euro also. Thus, the exchange rate will shift back to the desired level.
Other two initiatives will further appreciate the Value of Dollars w.r.t. Euro. Thus, stated objective will not be achieved.
Correct Answer:
The US unemployment rate rises at first, but then it drops as US dollar depreciates against Brazilian reals.
US dollar depreciates due to increase in demand of Brazilian reals. It means that unemployment levels in the USA is improving and it is building demand for the Brazilian goods.
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