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38-2 Indicate whether each of the following creates a demand for or a supply of French francs in foreign exchange markets:
a. A U.S. importer purchases a shipload of Bordeaux wine.
b. A French automobile firm decides to build an assembly plant in Los Angeles.
c. A U.S. college student decides to spend a year studying at the Sorbonne.
d. A French manufacturer ships machinery from one French port to another on a Liberian
freighter.
e. The U.S. economy grows faster than the French economy.
f. A U.S. government bond held by a French citizen matures and the loan amount is paid
back to that person.
g. It is widely believed that the international value of the franc will fall in the near
future.
38-3 Alpha’s balance of payments data for 1998 are shown below. All figures are in billions of dollars. What are (a) the balance of trade (b) the balance on goods and services (c) the balance on current account and (d) the balance on capital account? Does Alpha have a balance of payments deficit or surplus? Explain.
| Goods exports | + $40 | Net transfers | + $10 |
| Goods imports | - 30 | Foreign purchases of assets in the United States | + 10 |
| Service exports | + 15 | U.S. purchases of assets abroad | - 40 |
| Service imports | - 10 | Official reserves | + 10 |
| Net investment income | - 5 |
38-6 Explain why the U.S. demand for Mexican pesos is downsloping and the supply of pesos to Americans is upsloping. Assuming a system of flexible exchange rates between Mexico and the United States indicate whether each of the following would cause the Mexican peso to appreciate or depreciate:
a. The United States unilaterally reduces tariffs on Mexican products.
b. Mexico encounters severe inflation.
c. Deteriorating political relations reduce American tourism in Mexico.
d. The U.S. economy moves into a severe recession.
e. The United States engages in a high-interest-rate monetary policy.
f. Mexican products become more fashionable to U.S. consumers.
g. The Mexican government encourages U.S. firms to invest in Mexican oil fields.
h. The rate of productivity growth in the United States diminishes sharply.
38-10 Diagram a market in which the equilibrium dollar price of one unit of fictitious currency Zee is $5 (the exchange rate is $5 5 Z1). Then show on your diagram a decline in the demand for Zee.
a. Referring to your diagram
discuss the adjustment options the United States would
have in maintaining the exchange rate at $5 5 Z1 under a fixed exchange-rate system.
b. How would the U.S. balance of payments surplus which is created (by the decline in
demand) get resolved under a system of flexible exchange rates?
Answers:
| 38-2 A demand for francs is created in (a) (c) and (f). A supply of francs is created in (b) (d) (e) and (g).
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| 38-3 Balance of trade = $10 billion surplus (= exports of goods of $40 billion minus imports of goods of $30 billion). Balance on goods and services = $15 billion surplus (= $55 billion of exports of goods and services minus $40 billion of imports of goods and services). Balance on current account = $20 billion surplus (= credits of $65 billion minus debits of $45 billion). Balance on capital account = $30 billion deficit (= Foreign purchases of assets in the United States of $10 billion minus U.S. purchases of assets abroad of $40 billion). Balance of payments = $10 billion deficit.
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| 38-6 The U.S. demand for pesos is downsloping: When the peso depreciates in value (relative to the dollar) the United States find that Mexican goods and services are less expensive in dollar terms and purchase more of them demanding a greater quantity of pesos in the process. The supply of pesos to the United States is upsloping: As the peso appreciates in value (relative to the dollar) U.S. goods and services become cheaper to Mexicans in peso terms. Mexicans buy more dollars to obtain more U.S. goods supplying a larger quantity of pesos. The peso appreciates in (a) (f) (g) and (h) and depreciates in (b) (c) (d) and (e).
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| 38-10 See the graph illustrating the market for Zees. (a) The decrease in demand for Zees from D1 to D2 will create a surplus (bc) of Zees at the $5 price. To maintain the $5 to Z1 exchange rate the United States must undertake policies to shift the demand-for-Zee curve rightward or shift the supply-of-Zee curve leftward. To increase the demand for Zees the United States could use dollars or gold to buy Zees in the foreign exchange market employ trade policies to increase imports from Zeeonia or enact expansionary fiscal and monetary policies to increased U.S. domestic output and income thus increasing imports from Zeeonia. Expansionary monetary policy would also reduce the supply of Zees: Zeeons would respond to the resulting lower U.S. interest rates by reducing their financial investing in the United States. Therefore they would not supply as many Zees to the foreign exchange market. (b) Under a system of flexible exchange rates the bc surplus of Zees (the U.S. balance of payments surplus) will cause the Zee to appreciate and the dollar to appreciate until the surplus is eliminated (at the $4 5 Z1 exchange rate shown in the figure).
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