1. Assume that the United States trades exclusively with Mexico and that the exc
ID: 2440811 • Letter: 1
Question
1. Assume that the United States trades exclusively with Mexico and that the exchange rate between the U.S. and the Mexico is flexible.
a. Assume that Americans desire more goods that are made in the Mexico. Show and explain how this change in demand will affect each of the following:
-The demand for U.S. dollars
-The international value of the U.S. dollar
-The international value of the U.S. dollar
-The quantity of U.S. dollars supplied in the foreign exchange market
1. Assume that the United States trades exclusively with Mexico and that the exchange rate between the U.S. and the Mexico is flexible.
a. Assume that Americans desire more goods that are made in the Mexico. Show and explain how this change in demand will affect each of the following:
-The demand for U.S. dollars
-The international value of the U.S. dollar
b. Now, assume that there is an increase in real interest rates in the Mexico, but not in the United States. Show and explain how this increase in interest rates will affect each of the following:-The international value of the U.S. dollar
-The quantity of U.S. dollars supplied in the foreign exchange market
Explanation / Answer
(a)
(i) As Americans desire more Mexican goods, US import demand from Mexico rises. Higher import demand increases the demand for Mexican peso, and decreases the demand for US dollar.
(ii) Lower demand for US dollar decreases its international value.
(b)
(i) Higher relative interest rate in Mexico will increase global investment in Mexico, increasing the demand for Mexican peso and decreasing the demand for US dollar.
(ii) Higher demand for Peso means investors will sell US dollars to buy peso, therefore quantity of US dollars supplied will increase.
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