Page 871 - Krugmans Economics for AP Text Book_Neat

S-25
SOLUTIONS TO AP REVIEW QUESTIONS

Exchange rate Exchange rate
(euros per (U.S. dollars
U.S. dollar) Supply of per yuan) S
U.S. dollars, S 1
S 2
Equilibrium
XR 1 E 1 exchange E
XR 2 E 2 rate XR*
$0.121
D
Target
Quantity of U.S. dollars exchange D
rate
0 Quantity of yuan

Module 43 b. Placing restrictions on foreigners who want to invest in
Check Your Understanding China would reduce the demand for the yuan, causing
1. The accompanying diagram shows the supply of and the demand curve to shift in the accompanying diagram
from D to something like D . This would cause a reduc-
1
2
demand for the yuan, with the U.S. dollar price of tion in the shortage of the yuan. If demand fell to D , the
3
the yuan on the vertical axis. In 2005, prior to the disequilibrium would be completely eliminated.
revaluation, the exchange rate was pegged at 8.28
yuan per U.S. dollar or, equivalently, 0.121 U.S. dollars
per yuan ($0.121). At the target exchange rate of Exchange rate
(U.S. dollars
$0.121, the quantity of yuan demanded exceeded the per yuan) S
quantity of yuan supplied, creating the shortage
depicted in the diagram. Without any intervention by
the Chinese government, the U.S. dollar price of the
yuan would be bid up, causing an appreciation of the E 1
yuan. The Chinese government, however, intervened to Target
exchange $0.121
prevent this appreciation. rate E 2
D 1
D 2
D 3
Exchange rate
(U.S. dollars S 0 Quantity of yuan
per yuan)
c. Removing restrictions on Chinese who wish to invest
E abroad would cause an increase in the supply of the yuan
Target
exchange $0.121 and a rightward shift of the supply curve. This increase in
rate supply would reduce the size of the shortage. If, for
example, supply increased from S to S , the disequilibri-
Shortage 1 2
of yuan D um would be eliminated completely, as shown in the
accompanying diagram.
0 Quantity of yuan
Exchange rate
(U.S. dollars
per yuan) S 1
a. If the exchange rate were allowed to float more freely, the S 2
U.S. dollar price of the exchange rate would move toward
the equilibrium exchange rate (labeled XR* in the accom-
panying diagram). This would occur as a result of the E 1
shortage, when buyers of the yuan would bid up its U.S. Target E 2
exchange $0.121
dollar price. As the exchange rate increased, the quantity rate
of yuan demanded would fall and the quantity of yuan
supplied would increase. If the exchange rate were
D
allowed to increase to XR*, the disequilibrium would be
entirely eliminated. 0 Quantity of yuan