Question 4 Chapter 19 Analyzing the effects of a trade deficit another version
You have just been hired by the U.S. government to analyze the following
... [Show More] scenario. Suppose the U.S.
manufacturing industry is concerned about competition from overseas low-cost producers exporting their
goods to the United States, a practice that hurts domestic producers. Lobbyists claim that implementing a
quota on imports would shrink the size of the deficit. The following exercise will help you to analyze this
claim.
The following graph shows the demand and supply of U.S. dollars in a model of the foreign-currency
exchange market.
Shift the demand curve, the supply curve, or both to show what would happen if the government decided to
implement the quota.
Your Answer
SuppIy
Demand
SuppIy
D2
D1
QUANTITY OF DOLLARS
REAL EXCHANGE RATE (Units of foreign currency per doIIar)
Correct Answer
appreciates
Explanation: Close Explanation
When the U.S. government imposes a quota, net exports will rise for any given real exchange rate.
This change translates in this model into an increase in the demand for dollars, which leads to an
increase in the real exchange rate. Therefore, the value of the dollar has appreciated.
Recall that the supply curve in this model of the foreign-currency exchange market is derived from net
capital outflow, which is affected only by the real interest rate, not the real exchange rate. Hence, the
supply curve does not shift in this scenario.
No change No change
Points: 1 / 1
Given this change, the value of a dollar .
Points: 1 / 1
Now that we've examined the effect of a quota on the foreign-currency exchange market, let's take a look at
what happens in the loanable funds market and with some other equilibrium concepts. Fill in the following
table with the effect of a quota on the following items:
Change due to
a quota
Demand for
Loanable Funds
Real Interest
Rate
Net Capital
Outflow Net Exports
Points: 1 / 1
Explanation: Close Explanation
No change No change
When the government imposes a quota on foreign-produced goods, there is no change in any part of
the market for loanable funds. This includes the demand for loanable funds (domestic investment and
net capital outflow), the supply of loanable funds (national saving), and the real interest rate. Although
the demand for dollars increases because net exports rise for any given real exchange rate, the rise in
the real exchange rate also dampens net exports, counteracting the initial effect of the quota. The end
result is no change in net exports, so the lobbyists were incorrect in their original assessment. [Show Less]