It follows i a depreciation of domestic currency

This preview shows page 39 - 51 out of 73 pages.

It follows: I a depreciation of domestic currency leads to an increase in output in the short run I an appreciation of domestic currency leads to a decrease in output in the short run
Image of page 39

Subscribe to view the full document.

How does the exchange rate a § ect output in the short run?
Image of page 40
How does the exchange rate a § ect output in the short run? I The e § ect of changes in E on output: I an increase in E tends to increase Y I a decrease in E tends to decrease Y I We use the above observations to derive a DD curve : I this curve will show all the combinations of the output and exchange rate that are compatible with output market equilibrium in the short-run
Image of page 41

Subscribe to view the full document.

Deriving the DD schedule
Image of page 42
Factors that a § ect the DD schedule I The same factors that a § ect the aggregate demand a § ect also the DD schedule: I government demand I investment demand I taxes I domestic and foreign prices I foreign income and foreign taxes I We next study how a change in any of these factors a § ect the DD schedule I we will change one factor at a time keeping other things constant
Image of page 43

Subscribe to view the full document.

A change in G I An increase in G leads to an increase in the aggregate demand
Image of page 44
A change in domestic taxes I Conisder an increase in the domestic taxes I An increase in the domestic taxes decreases households’ disposable income I consumption goes down and current account goes up I the first e § ect dominates and hence the aggregate demand goes down I it follows that the DD curve shifts to the left I The opposite is true for a decrease in domestic taxes
Image of page 45

Subscribe to view the full document.

A change in foreign taxes I Conisder an increase in the foreign taxes I An increase in the foreign taxes decreases foreign households’ disposable income I foreign households cut on consumption of domestic goods I domestic export falls I hence, the aggregate demand for domestic goods falls I and the DD curve shifts to the left I Again, the opposite is true for a decrease in foreign taxes
Image of page 46
A change in domestic prices I Conisder an increase in domestic prices I An increase in P I given E and P , an increase in P makes domestic goods relatively more expensive I this lowers exports and increases imports I the aggregate demand decreases (D curve shifts down) I it follows that Y falls at any given level of E I as a consequence DD schedule shifts to the left
Image of page 47

Subscribe to view the full document.

A change in foreign prices I An increase in P I given E and P , an increase in P makes foreign goods relatively more expensive I this increases exports and lowers imports I the aggregate demand decreases (D curve shifts up) I it follows that Y increases at any given level of E I as a consequence DD schedule shifts to the right
Image of page 48
A shift in demand I Suppose that there is a change in tastes (a new fashion): I e.g. domestic and foreign residents decide to consume more of the domestic goods relative to the foreign goods I What will happen? I this leaves total consumption spending unchanged but shifts consumption towards domestic goods I as a consequence exports increase and imports fall increasing aggregate demand I therefore, DD schedule shifts to the right
Image of page 49

Subscribe to view the full document.

Changes in the consumption function I Suppose that there is a change in the consumption function I e.g. suddenly people become less optimistic about the future
Image of page 50
Image of page 51

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern