Question

Analyze the effect of the following shocks on the equilibrium values for real and nominal exchange rates in the long run.

(use graph)

1. Technological improvement in the US.

2. Increase in government spending in the US on US military goods.

3. Increase in monetary growth in the US.

4. World preferences change away from Japanese cars toward US cars.

5. Increase in the world price of oil, supported by a reduction in its supply.

E = a a ML (Y*,R*) maz (Y,8). - - - - I foreign goods domestic goods E -- - _ R* + EP - R, RH+ BLE Lly, R) slo -- o

Answer 1

In the long run, we can easily determine the value for real and nominal exchange rate using the following diagram under different type of circumstances.

(1) Technological improvement in the US :- As there is a improvement of technology happens then definitely the quantity of output increases. After improvement the supply curve is shifts to right. Here is the suitable figure of this situation.

9- EPF DH

(2) Increase in government spending in the US on US military goods :- As government spending increases then the exchange rate is also increases. Here is the figure.

(3) Increase in monetary growth in the US :- As there is an increase in monetary growth in US then (M/P) curve will shifts upward direction and as a result the equilibrium "R" shifts from "R₀" to "R₁". Here is the suitable figure.

a (PR) -Me), o Ro Rik

(5) Increase in the world price of oil, supported by a reduction in its supply :- If the world price of oil increases by the reduction in its supply then the supply curve will shifts to the left and as a result the equilibrium real exchange rate will decreases and nominal exchange rate will increases. Here is the figure.

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