Supply of Foreign Exchange in the Foreign Exchange Market - Assignment Example

Macroeconomics Name: Institution: Date: Question one i) Gross investment=$(500,000+400,000) =$900,000 Depreciation=$100,000 Net Investment=$(900,000-100,000) =$800,000 ii) Value at the end of 2012=$(900,000-100,000) =$800,000 b) How much did Lori save in 2012? Explain $10,000.She had an injection of $20,000+$5,300 and consumed $15,300 leaving her with 10,000 balances as savings. ii) What was her wealth at the end of 2012? $9,000 Wealth is a measure of total market value of physical and tangible assets less debts owing. c) Suppose that the government has a budget surplus of $1 billion. What is the real interest rate-8%, the quantity of investment and the quantity of private saving? Does any crowding out occur? The real interest rate will be 6%.Since the government budget is balanced, the investment will equal savings amount. therefore quantity of investments and private savings will equal $8.5billion. (b) Suppose that the government has a budget deficit of $1 billion. What is the real interest rate, the quantity of investment and the quantity of private saving? Does any crowding out occur? Equilibrium real interest rate is 7%. The equilibrium quantity of loanable funds is $8.0 billion; the quantity of investment is $8.0 billion while the equilibrium quantity of private saving will be $9.0 billion. There is crowding out effect of $500 million of investment. (c) Suppose that the government has a budget deficit of $1 billion and the Ricardo–Barro effect occurs, what are the real interest rate and the quantity of investment? the new real interest rate will be 7%, the quantity of investment is $8 billion, and the quantity of private saving is $8 billion since the barro effect has no impact on the level of private savings and investment as well as the equilibrium interest rate. Question 2: (a) What are the official measures of money? (1 mark) Monetary aggregates which includes M1(Notes and coins in circulations plus demand deposits),M2(transaction accounts as well as liquid savings accounts +M1) and M3(M1+M2+time deposits, institutional money markets funds and MMDA) Dimension of the liquidity concept which includes the ease to transfer money to GPP and certainty of asset value in money terms. (b) Explain with reason if visa card, coins and cheque’s are money? (1.5 mark) Visa Card and cheques are forms of representative money. Coins are fiat money since they are intrinsically worthless and inconvertible. (c) Explain the key functions of money? (1.5 marks) Medium of exchange-here money facilitates transactions due to its acceptance as a mode of payment. Store of value-Money is used to transfer value from period t to t+1. Standard of deferred payments-Deferred payments are settled using money. Money is also used as a Transfer of immovable assets and a measure of value for items. (d) Explain the factors that determine the demand for and supply of money, and show how a change in the supply of money (increase/ decrease) can cause a change in the equilibrium interest rate. Demand for money is determined by three motives According to Keynes Liquidity preference theory: Transactionery demand –individuals hold money because it’s a motion of exchange that can be used to carry out transactions. It’s positively related to real income and inflation rates. Precautionary demand-people hold money as a cushion against unexpectedexpenses. It’s also positively related to real income and inflation. Speculative demand –money is used as a store of wealth but when interest rates are high bond prices are expected to rise. This motive is negatively related to interest rate. Supply for money is determined by the money multiplier factors which are: Currency ratio- negatively related to money supply. Excess reserve ratio-It’s negatively correlated to money supply. Required reserve ratio-Has Negative relationship with money supply. If interest rates go up, the excess reserves banks hold go down and vice versa. It can be illustrated below. Question 3: (a) What are the factors that determine the change in the demand for, and supply of foreign exchange in the foreign exchange market? supply of foreign currency is determined by foreign residents purchasing domestic commodities while demand is determined by demand imports. Variables that affect demand and supply of foreign exchange include: inflation rate growth rate interest rate Government restrictions. Source: forex1.pptx‎ 1 The figure above shows demand and supply of foreign currency whose intersection gives the equilibrium exchange rate. (b) On 3rd of August 2010, the U.S. dollar was trading at 86 yen per U.S. dollar on the foreign exchange market. On 13 September 2010, the U.S. dollar was trading at 83 yen per U.S. dollar. (i) What events in the foreign exchange market might have brought this fall in the value of the U.S. dollar? Changes in income levels of the trading partner.A fall in value resulted in less demand for the US dollar. Inflation rate differences–The US inflation rate rose causing the currency to be expensive compared to the trading partners Relative high product prices Expansionary monetary supply. (ii) Did the events change the demand for U.S. dollars, the supply of U.S. dollars, or both demand and supply on the foreign exchange market? Depreciation changes both the demand and supply of the home currency. While the demand increases because of it becoming cheper, supply must also be cut to restore equilibrium in the long run Question 4: (a) Future Looking a Little Less Golden: “The risk of weaker growth, possibly recession, looms over the global economy in 2012. The intensification of the European sovereign debt crisis andhome-grown issues in China, are undermining the growth outlook. The copious quantities of government stimulus in recent years are now the problem, not the solution”. Source: The Age, 27 December 2011. (i) Why was there a risk of global recession in 2012? (1 mark) Due to The intensification of the European sovereign debt crisis and home-grown issues in China which may have resulted in consumer confidence erosion since they are the central test and are major trading partners globally of most nations. Their slump growth could have resulted in international recession. (ii) Illustrate the effects of recession on Australia’s short-run macroeconomic equilibrium. (1 mark) The aggregate demand curve shifts to the left, both the price level and real output decline. Long run: The aggregate supply curve shifts to the right, the price level falls further, and real output increases. Price AS1 Level AS2 P1 P2 AD2 AD1 GDP1 GDP2 Real GDP (iii) Why the large stimulus packages were used by the Australian governments in 2009, as a response to the last global recession now the problem, and not the solution? Stimulus packages operate in a political environment characterised by the unpopularity of increased taxes. Specific decrease in spending may lead to the most appropriate economic policies getting ignored for political reasons. Secondly, there are offsetting decisions which may be made at any particular time in the private or international sectors. Therefore, efforts to revive the economy with more economic stimulus resulted in crowding out effect (reduced private investment) or a decrease in net export levels. (b) Using aggregate demand (AD) and aggregate supply (AS) model illustrate and explain the short run equilibrium situations The aggregate demand curve shifts to the left, both the price level and real output decline. Long run: The aggregate supply curve shifts to the right, the price level falls further, and real output increases. Price AS1 Level AS2 P1 P2 AD2 AD1 GDP1 GDP2 Real GDP (b) Illustrate and explain the key reasons as to why real GDP fluctuates around the potential GDP. Fig 1 Source: Euro Economics 2009 The general trend shows potential GDP growing at a fairly constant rate with time. Any deviation from the curve is referred to as economic fluctuations. The general trend can be explained using the graph below. Fig 2 source: Euro Economics 2009 The intersection of the three lines depicts the economy in long-run equilibrium. At this point the economy is producing at the level that labor, capital, and technology would dictate according to the long-run aggregate supply curve (YN). The economy is at its natural rate. The natural rate can change through time if there are changes to the long-run aggregate supply curve[Eur09]. References Eur09: , (EUCE, 2009, p. para.4), Read More