Question

QUESTION 1
1.1 Illustrate on the following diagram of the South African foreign exchange market what will happen to the exchange rate between the rand and the US dollar if South Africa implements export promotion measures. Remember to label your diagram.

1.2. Use a diagram to explain how a decrease in the interest rate will affect the quantity of money demanded in the money market.

1.3 Suppose the Minister of Finance has asked you to advise him on the formulation of a tax policy. Write a paragraph that will explain what your major considerations will be when you design this tax policy.

Answer 1

1.1. Following the implementation of export promotion the supply of foreign exchange (upward sloping curve) increases (moves downward) while the demand for foreign exchange (downward sloping curve) remaining the same. So equilibrium exchange rate (measured at vertical axis) decreases. Hence appreciation takes place.

1.2. Rate of interest is the cost of holding money. So if interest rate rises demand for money falls and therefore we will get a downward sloping curve by measuring rate of interest and money demand at the vertical and horizontal axis respectively.