ACJC External Macro Tutorial Worksheet Section A and B Answers

1 External Macro Issues: Tutorial Worksheet Suggested Answers Section A: Discussion Questions Note to teachers: This question was assigned as one of the SLS questions. Question 1: Understanding exchange rate changes Different countries’ governments may choose to adopt different exchange rate regimes. For this question, we will assume that all three countries (UK, US and Malaysia) adopt a floating exchange rate regime. Event Explain the impact of the event on the country’s exchange rate A rise in domestic interest rates in UK, making them above the rates in many other developed countries. 1. Explain the impact on the demand for bank deposits in UK: Higher interest rate in UK relative to other countries will lead to an increase in short term capital inflow into UK (i.e. hot money: increase in bank deposits by foreigners). 2. Explain the impact on the foreign exchange market: The demand for UK’s £ increases since bank deposits made in foreign currencies must be converted to £, creating a shortage at the original equilibrium price, exerting upward pressure on the equilibrium price to rise. UK’s £ appreciates (currency strengthens). US reports that its trade deficit is the highest in recent years. 1. Explain what is meant by trade deficit: Trade deficit suggests that export revenue is less than import expenditure. US’s trade deficit may be a result of higher demand for imports. 2. Explain the impact on the foreign exchange market: To pay for the imports in foreign currencies, the supply of US$ would have to increase, creating a surplus at the original equilibrium price, exerting downward pressure on the equilibrium price to rise. US$ depreciates (currency weakens). Malaysia’s export price competitiveness improves 1. Explain what is meant by an improvement in export price competitiveness: Malaysia’s exports are now cheaper, leading to an increase in quantity demanded of Malaysia’s exports, ceteris paribus. 2. Explain the impact on the foreign exchange market: The demand for MYR increases since payment for Malaysia’s exports must be made in MYR, creating a shortage at the original equilibrium price, exerting upward pressure on the equilibrium price to rise. MYR appreciates (currency strengthens).

2 Question 2: Understanding balance of payments Note to teachers: This question was assigned as one of the SLS questions. With respect to Singapore’s balance of payment account, identify and explain which of the accounts would likely be affected by each of the following events. Events Account A rise in expenditure by tourists in Singapore. Current account (goods balance and/or services balance) Reason: Higher export revenue. Note that export revenue will be recorded as a credit entry due to the inflow of money. Current account improves. An increase in import duties on cigarettes in Singapore. Current account (goods balance) Reason: Lower imported expendit