Question

Suppose that, due to domestic inflation, U.S. prices are rising relative to the European Union. a. What impact would this inflation have on i) U.S. imports, ii) U.S. exports, iii) U.S. trade balance, and iv) prices in the EU? b. If the U.S. has a floating exchange rate regime, what impact would you expect the inflation to have on the U.S. exchange rate, if any? Would the dollar appreciate or depreciate? c. Based on your answer to b), what would then happen to U.S. imports, exports, trade balance and prices in the EU? B I U SIX 를 들 Х, x? Insert Formula

Answer 1

Impact of inflation in US in relation to EU

A. due to inflation in US, price of domestic goods will rise. As a result domestic goods will become costlier in relation to goods produced in EU. As a result following changes will take place:

US imports will increase as domestic goods are costlier.

US exports will decrease as due to inflation goods produced in US are now expensive. Therefore exports will decline.

Due to excess of imports over exports, there will be trade deficit. Which means that there will be more outflow of foreign exchange and less inflow of foreign currency. Trade balance is also termed as net exports which is defined as the difference bewteen exports and imports.

Due to increase in US demand for goods manufactured in EU, prices of goods produced in EU will rise.

Answer b.

Floating exchange refers to rate of exchange which is determined by market forces of demand and supply.their is no government intervention.

Due to rise in inflation in US , import from EU will rise and exports from US will decline.

Due to rise in Imports , demand of foreign currency ( EU) will rise and demand curve will shift rightward. As a result the equilibrium rate of exchange will also rise. This will result in Depreciation of US dollar.

Due to fall in exports from US, supply of foreign currency will decline and supply curve will shift LEFTWARD. As a result equilibrium rate if exchange will rise resulting in Depreciation of US dollar.

Answer c)

Due to Depreciation in US Dollar, imports will now decline. This is because now more units of US dollar are required to buy a unit of foreign currency ( EU). DEPRECIATION refers to increase in the foreign exchange rate or decrease in external purchasing power of domestic currency in terms of foreign currency.

Due to Depreciation in US dollar, exports from US will increase. This because with same unit if foreign currency goods worth more US Dollar can now be purchased. Exports become cheaper and imports become costlier.

Due to rise in exports and fall in Imports, there will be trade surplus in current account of BOP.

Due to Depreciation of US dollar, demand for goods produced in EU will fall, as result prices will rise to attract demand.