Question

Suppose that, initially, the U.S. economy was in an aggregate demand-aggregate supply equilibrium at point A along with the aggregate demand curve AD in the diagram below. Now, however, the value of the U.S. dollar suddenly appreciates relative to foreign currencies. This appreciation happens to have no measurable effects on either the short-run or the long-run aggregate supply curve in the United States. It does, however, influence U.S. aggregate demand.

a. Explain in your own words how the dollar appreciation will affect net export expenditures in the United States.

b. Of the alternative aggregate demand curves depicted in the figure- $A{D}_1$versus $A{D}_2$which could represent the aggregate demand effect of the U.S. dollar's appreciation? What effects does the appreciation have on real GDP and the price level?

c. What policy action might the Federal Reserve take to prevent the dollar's appreciation from affecting equilibrium real GDP in the short run?

Short answer

a. imports increase and exports decrease prompting lower net exports from the country.

b. A decrease in the AD is reflected in the descending movement of the $A{D}_1$bend to one side. The $A{D}_2$is then the Aggregate Demand impact of the US dollar's appreciation.

c. The drive pushes the $A{D}_1$from $A{D}_2$to $AD$and subsequently rectifies the negative and descending patterns of the cost and Real GDP.

Step-by-step solution

introduction 

An expansion in the worth of cash in correlation with unfamiliar reference money in a drifting swapping scale framework is the enthusiasm for the money. A deficiency of worth of the money concerning unfamiliar cash is its deterioration.

explanation part (a) (1)

Stretching out the cash investigation to exchange between the two nations, let us accept that the US trades electronic products to India which thusly pays for this imported merchandise in rupees changed over completely to dollars at drifting paces of trade. Hence, the commodities of merchandise from the US to India fall because of the appreciation.

explanation part (b)

Dollar appreciation suggests a fall in the net products in the United States as examined to a limited extent. The Aggregate Demand has four parts Consumption Demand from the family area, Investment interest from the business area, Government interest and Net Exports from the unfamiliar area. A decrease in the AD is reflected in the descending movement of the $A{D}_1$ bend to one side. The$A{D}_2$ is then the Aggregate Demand impact of the US dollar's appreciation.

explanation part (c)

As clear from the parts (a) and (b) in the appreciation for the US dollar prompts a fall in the net products which suggests a fall in the total interest (AD) from $A{D}_1$to $A{D}_2$ , it prompts a fall in the cost level. To forestall the event of such unfavourable consequences for the Real GDP and Price Level, the Federal Reserve needs to take on an expansionary strategy to build the total interest in the economy. The expansionary strategy expands the user base in the economy by expanding the money supply, discretionary cash flow and in this way interest