Chapter 17, Problem 4P

(a)

To determine

Identify the real exchange rate in terms of cars and net export of cars to Japan, if the nominal exchange rate is 100.

Explanation of Solution

The real exchange rate measures the relative price of domestic goods to the foreign goods. The real exchange rate of dollar means the relative price of US car with Japanese car, which can be calculated as follows:

$\begin{array}{c}\mathrm{Re}\text{lative price of US car}=\frac{\text{US car cost}}{\text{Japanese car cost}}\\ =\frac{20,000}{25,000}\\ =0.8\end{array}$

The real exchange rate of dollar is 0.8, which means the US car is cheaper in the economy.

The US car is priced as 20,000 dollar. If 1 dollar is equal to 100 Yen, then the US car’s cost can be found as follows:

$\begin{array}{c}\text{Car cost}=\text{Car price in dollar}\times \text{Value of 1 dollar}\\ =20,000\times 100\\ =2000,000\end{array}$

If the US car’s cost is 2000,000 and Japanese car’s cost is 2,500,000 dollar, then the real exchange rate of Yen can be calculated as follows:

$\begin{array}{c}\mathrm{Re}\text{lative price of Japanese car}=\frac{\text{US car cost}}{\text{Japanese car cost}}\\ =\frac{2000,000}{2,500,000}\\ =0.8\end{array}$

The real exchange rate of Yen is 0.8.

The US exports are based on the Japanese demand for the US cars, and the US imports are based on its demand on Japanese cars. Japanese demand on the US car can be calculated as follows:

$\begin{array}{c}\text{Jpanese demand}=(10,000-(0.001\times \text{Price of US cars in Yen})\\ =(10,000-(0.001\times \text{2,000,000})\\ =10,000-2,000\\ =8,000\end{array}$

Japanese demand on the US car is 8,000 cars.

The US demand on the Japanese car can be calculated as follows:

$\begin{array}{c}\text{US demand}=(30,000-(0.2\times \text{Price of Japanese cars in dollar})\\ =(30,000-(0.2\times \text{25,000})\\ =30,000-5,000\\ =25,000\end{array}$

Japanese demand on the US car is 25,000 cars.

The net export of the US made car to Japan can be calculated as follows:

$\begin{array}{c}\text{Net export}=\text{US demand for car}-\text{Japanese demand for car}\\ =8,000-25,000\\ =-17,000\end{array}$

The net export of the US made car to Japan is -17,000 cars.

Economics Concept Introduction

Nominal exchange rate: The nominal exchange rate is the number of domestic currency needed to purchase the number of foreign currency.

Real exchange rate: The real exchange rate measures the relative price of domestic goods to the foreign goods.

(b)

To determine

Identify the real exchange rate in terms of cars and net export of cars to japan if the nominal exchange rate is 125.

Explanation of Solution

If the nominal exchange rate is increased from $100 to $125, both the US and Japanese car cost $20,000. The real exchange rate of dollar means the relative price of US car with Japanese car can be calculated as follows.

$\begin{array}{c}\mathrm{Re}\text{lative price of US car}=\frac{\text{US car cost}}{\text{Japanese car cost}}\\ =\frac{20,000}{20,000}\\ =1\end{array}$

The real exchange rate of dollar is 1. Which means the US car price equally to the Japanese made cars.

The US car priced 20,000 dollar. If 1 dollar is equal to 125 Yen. Then we can find the US car cost as follows.

$\begin{array}{c}\text{Car cost}=\text{Car price in dollar}\times \text{Value of 1 dollar}\\ =20,000\times 125\\ =2,500,000\end{array}$

If the US car and Japanese car cost is 2,500,000 dollar. The real exchange rate of Yen can be calculated as follows.

$\begin{array}{c}\mathrm{Re}\text{lative price of Japanese car}=\frac{\text{US car cost}}{\text{Japanese car cost}}\\ =\frac{2,500,000}{2,500,000}\\ =1\end{array}$

The real exchange rate of Yen is 1.this means relative to Japanese made car, US car price increased due to an appreciation of dollar.

The US exports are based on the Japanese demand for US cars. And US imports based on its demand on Japanese cars. Japanese demand on US car can be calculated as follows.

$\begin{array}{c}\text{Jpanese demand}=(10,000-(0.001\times \text{Price of US cars in Yen})\\ =(10,000-(0.001\times \text{2,500,000})\\ =10,000-2,5000\\ =7,500\end{array}$

Japanese demand on US car is 7,500 cars.

US demand on Japanese car can be calculated as follows.

$\begin{array}{c}\text{US demand}=(30,000-(0.2\times \text{Price of Japanese cars in dollar})\\ =(30,000-(0.2\times \text{20,000})\\ =30,000-4,000\\ =26,000\end{array}$

Japanese demand on US car is 26,000 cars.

The new net export of US made car to Japan can be calculated as follow.

$\begin{array}{c}\text{Net export}=\text{US demand for car}-\text{Japanese demand for car}\\ =7,500-26,000\\ =-18,5000\end{array}$

The net export of US made car to Japan is -18,500 cars.

(c)

To determine

Effects of appreciation US dollar in net exports of automobiles.

Explanation of Solution

When US dollar appreciate, the US exports become expensive related to Japanese. And the US imports become cheaper. This will reduce the US exports to Japan and US imports more from Japanese. Because Japanese cars become cheaper to US.