Topic 5: Modeling the Exchange Rate

Question 1

Show a perfect, holy and fully labelled S&D diagram for exchange

Answer 1

Question 2

Why is the D_fcurve downwards sloping?

Answer 2

An increased S(d/f) means more d per f,

Less inclination to import, Decrease in Df

Question 3

Why is the S_f curve upward sloping?

Answer 3

Increased S(d/f) means increased dc price of exports

This increases the supply of foriegn currency,

Question 4

What equations can we use to model D_f & S_f?

Answer 4

S_f = P*_XQ_X

D_f=P*_MQ_M

Question 5

Explain what happens to the exchange rate when australia outgrows another country, using the exchange D&S model.

Answer 5

D_f = P*_MQ_M is increasing because Q_M is increasing

This will increase S(d/f), which is a depreciation of the local currency.

Diagram not included.

Question 6

Say Q_M^d = 40 - 2.1P

USD price of exports is 2.5

S(AU/US) = 1.8769

What is demand for forex?

Answer 6

Q_M^d= 40 - 2.1*2.5*1.8769 = 34.75

34.75 * P* = 34.75 * 2.5 = 86.875

Question 7

What is a dynamic model?

Answer 7

A model which analyses a time-dependent mathematical relationship, and consists of a sequence of operations which changes with reference to time.

Question 8

Define comparative statics.

Answer 8

Comparative statics is the analysis of changes in outcomes, given changes in exogenous variables that move the system from one static equilibrium to another.