Explain how international transactions, exchange rates, foreign exchange markets, net exports, real interest rates, and capital flows connect an economy to the world.
Assume that the economy of Vortania is in long-run equilibrium.
Vortania and Rhodara are trading partners with flexible exchange rates. The currency of
Vortania is the Vortanian crown (VTC), and the currency of Rhodara is the Rhodaran mark
(RHM). Assume that Vortania's capital and financial account (CFA) balance is zero. Now
assume that Vortania imposes new tariffs on imports from Rhodara. Draw a correctly labeled
graph of the foreign exchange market for the Vortanian crown, and show the effect of the
tariffs on the SUPPLY of the Vortanian crown and the international value of the Vortanian
crown.
Based solely on the change in the international value of the Vortanian crown shown in part
C, will Vortania's net exports increase, decrease, or remain the same in the short run?
Based on the change in net exports identified in part D, what will happen to each of the
following in the short run?
The capital and financial account (CFA) balance in Vortania. Explain.
Assume the central bank of Vortania wants to return the Vortanian crown to its international
value before the imposition of the tariffs. Would the central bank buy or sell Vortanian
crowns in the foreign exchange market? Explain.
Italy and Japan are trading partners and have flexible exchange rates. The Italian currency is the euro and the Japanese currency is the yen.
Suppose that the exchange rate between the euro and the yen is 1 euro =100 yen. What is the price of an Italian coat in yen if the coat costs 120 euros in Italy?
Assume that real interest rates increase in Japan. Identify what will happen to net financial capital flows between Italy and Japan.
Draw a correctly labeled graph of the foreign exchange market for the yen and show the effect of the increase in real interest rates in Japan on the value of the yen.
Based solely on the change in the exchange rate identified in part (c), what will happen to Italy's exports to Japan? Explain.
Begin your response to this question at the top of a new page in the separate Free Response booklet and fill in the appropriate circle at the top of each page to indicate the question number.
Exchange rates and interest rates are important for macroeconomic decision making.
How does an increase in Japan's government budget deficit affect each of the following?
The real interest rate in the short run in Japan. Explain.
Private domestic investment in plant and equipment in Japan
Draw a correctly labeled graph of the foreign exchange market for the euro, and show the effect of the change in the real interest rate in Japan from part (a)(i) on each of the following.
Supply of euros. Explain.
Yen price of the euro
To reverse the change in the yen price of the euro identified in part (b)(ii), should the European Central Bank buy or sell euros in the foreign exchange market?
