Question

Suppose the exchange rate changes so that fewer Japanese yen are required to buy a dollar. We would conclude that a. the Japanese yen has depreciated in value. b. U.S. citizens will buy fewer Japanese imports. c. Japanese will demand fewer U.S. exports. d. none of the above will occur.

Short answer

As the Japanese yen appreciates, Japanese goods become relatively more expensive for U.S. citizens. This results in U.S. citizens buying fewer Japanese imports since they are now more expensive in terms of dollars. Therefore, the correct answer is option B: U.S. citizens will buy fewer Japanese imports.

Step-by-step solution

Option A - Effect on the value of the Japanese yen

When fewer Japanese yen are required to buy a dollar, it means that the value of the Japanese yen has increased relative to the U.S. dollar. As a result, the Japanese yen has appreciated, not depreciated. Hence, option A is incorrect.

Option B - Effect on U.S. citizens buying Japanese imports

If the Japanese yen appreciates, it means that Japanese goods become relatively more expensive for U.S. citizens. As a result, U.S. citizens may buy fewer Japanese imports since they are now more expensive in terms of dollars. Therefore, option B is a possible result of the given situation.

Option C - Effect on Japanese demand for U.S. exports

As the Japanese yen appreciates, the purchasing power of Japanese consumers increases. This means that U.S. goods will now be cheaper for Japanese consumers in terms of yen. Consequently, the Japanese demand for U.S. exports may increase, not decrease. Thus, option C is incorrect.

Option D - The validity of "none of the above"

Since option B is a correct result of the given exchange rate change, option D stating that none of the above will occur is also incorrect.

Conclusion

Out of the four options provided, option B is the result of the given change in the exchange rate, where fewer Japanese yen are required to buy a dollar. We can conclude that U.S. citizens will buy fewer Japanese imports as a result of the appreciation of the Japanese yen.

Key concepts

Currency Appreciation and Depreciation

Understanding currency appreciation and depreciation is crucial in grasping the dynamics of global financial markets. When the value of a currency goes up in comparison to another, we call this appreciation. Conversely, when its value decreases, it's termed depreciation.

Let's consider an example with the Japanese yen and the U.S. dollar. If it takes fewer yen to buy a dollar, the yen is said to appreciate. This increase in value can have numerous economic implications: consumers in Japan may find imported goods more affordable, whereas U.S. products could become more expensive for American buyers. On the other hand, depreciation of the yen would make Japanese exports more competitive, potentially boosting Japan's economy.

In the given exercise, the incorrect choice is to conclude that the yen has depreciated because a reduction in the amount of yen needed to buy a dollar is, in fact, an indication of the yen's appreciation. This highlights the importance of accurately understanding currency changes, as they can have a direct impact on consumers' purchasing behavior and the overall economic environment.

International Trade Impacts

Currency values can dramatically affect international trade. When a country's currency appreciates, its exports can become more expensive and less competitive in global markets, potentially leading to a decrease in export volumes. Conversely, a weaker currency may boost exports by making them cheaper for international buyers.

Applying this to our scenario involving the Japanese yen, as the yen appreciates, U.S. citizens might indeed buy fewer Japanese imports due to higher costs. This demonstrates the broader economic principle of price elasticity of demand, where the demand for goods changes in response to price alterations. While a country might enjoy increased purchasing power abroad during currency appreciation, its domestic businesses relying on exports may experience challenges. This balance is an intricate aspect of international trade economics, influencing policy decisions and trade agreements.

Purchasing Power Parity

The concept of Purchasing Power Parity (PPP) is pivotal in understanding the long-term equilibrium states of exchange rates. PPP suggests that in the absence of transportation costs and barriers to trade, exchange rates should adjust so that the same basket of goods costs the same in each country.

If we notice that the price levels between two countries are out of sync, it's likely that their currencies will move towards an exchange rate that equalizes the prices of an equivalent basket of goods. This principle implies that over the long term, exchange rates should reflect the relative purchasing powers of different currencies.

In the context of currency appreciation, if the Japanese yen appreciates against the U.S. dollar, we might expect a shift towards equilibrium where goods in Japan and the U.S. would return to cost the same amount, adjusting for currency value. This long-term view helps analysts predict possible shifts in currency value based on observed price level differences. However, real-world factors such as trade policies, inflation rates, and market speculation can complicate this relationship.