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Chapter 21: Q6. (page 450)

Suppose that a Swiss watchmaker imports watch components from Sweden and exports watches to the United States. Also, suppose the dollar depreciates, and the Swedish krona appreciates, relative to the Swiss franc. Speculate as to how each would hurt the Swiss watchmaker.

Short Answer

Expert verified

The Swiss watchmaker will be hurt due to the loss of import of components from Sweden and the decline in the export of watches to the United States.

Step by step solution

01

Flexible exchange rate system

In a flexible exchange rate system, exchange rates are determined by the demand for and supply of individual national currencies in the foreign exchange market.

Thus, the equilibrium is obtained due to market forces of supply and demand. The volatility of flexible exchange rates may have several negative consequences, including discouraging international trade, worsening a nation's terms of trade, and destabilizing a nation's domestic economy by depressing export industries.

02

Case of Swiss watchmaker under flexible exchange rate 

The Swiss watchmaker imports watch components from Sweden, which means that the supply of dollars from Switzerland's official reserves is deteriorating (or the demand for dollars are increasing because everyone trades in dollars) and getting transferred to Sweden's economy.

While the export of watches manufactured in Switzerland will create an inflow of dollars (if the exchange of currency is not considered and assumed that Americans are paying in dollars) back into the Swiss economy.

A depreciation in dollars means (and appreciation of Swedish Krona), the Swiss watchmaker will require more dollar reserves to purchase the same quantity of components from the market of Sweden. In addition to that, since export pays for import, export of the same number of watches will create less inflow of dollars back to Switzerland.

Thus, consequently, the dollar depreciation will reduce imports of components from Sweden and the export of watches to the United States. The net effect will be a decline in the manufacturing of Swiss watches.

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Most popular questions from this chapter

ADVANCED ANALYSIS Return to problem 3 and assume that the exchange rate is fixed at 110. In year 1, what is the minimum initial size of the U.S. reserve of loonies such that the United States can maintain the peg throughout the year? What is the minimum initial size that is necessary at the start of year 2? Next, consider only the data for year 1. What peg should the United States set if it wants the fixed exchange rate to increase the domestic money supply by $1.2 trillion?

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Suppose that the current Canadian dollar (CAD) to U.S. dollar exchange rate is \(0.85 CAD = \)1 U.S. and that the U.S. dollar price of an iPhone is \(300. What is the Canadian dollar price of an iPhone? Next, suppose that the CAD to U.S. dollar exchange rate moves to \)0.96 CAD = $1 U.S. What is the new Canadian dollar price of an iPhone? Other things equal, would you expect Canada to import more or fewer iPhones at the new exchange rate? Explain.

Refer to the following table, in which Qd is the quantity of loonies demanded, P is the dollar price of loonies, Qs is the quantity of loonies supplied in year 1, and Qs′ is the quantity of loonies supplied in year 2. All quantities are in billions, and the dollar-loonie exchange rate is fully flexible.

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a. What is the equilibrium dollar price of loonies in year 1?

b. What is the equilibrium dollar price of loonies in year 2?

c. Did the loonie appreciate, or did it depreciate relative to the dollar between years 1 and 2?

d. Did the dollar appreciate or did it depreciate relative to the loonie between years 1 and 2?

e. Which one of the following could have caused the change in relative values of the dollar (used in the United States) and the loonie (used in Canada) between years 1 and 2: (1) More rapid inflation in the United States than in Canada, (2) an increase in the real interest rate in the United States but not in Canada, or (3) faster income growth in the United States than in Canada?

What do the plus signs and negative signs signify in the U.S. balance-of-payments statement? Which of the following items appear in the current account and which appear in the capital and financial account: U.S. purchases of assets abroad, U.S. services imports, foreign purchases of assets in the United States, U.S. goods exports, U.S. net investment income? Why must the current account and the capital and financial account sum to zero?

If the economy booms in the United States while going into recession in other countries, the US trade deficit will tend to ________.

a. increase

b. decrease

c. remains the same
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