Answer to Question #136074 in Macroeconomics for Thabiso

Question

An increase in criminal activity in South Africa act as a deterrent to foreign tourists considering visiting South Africa, and as a result there a decline in the number of American tourists to South Africa

Explain with the aid of a graph ,the effect of this on rand/dollar exchange rate and the equilibrium quantity for dollars

Answer 1

The rand depreciates in value and the equilibrium quantity of dollars exchanged in the foreign exchange market decreases.

American tourists who visit South Africa should exchange their American dollars with the South African rands. This implies that the tourists are the demanders of the rand. The decrease in the number of tourists to South Africa, therefore, represents a fall in the demand for rand. It is this decrease in the rand currency that pulls down its external value with regards to the American dollar: the rand depreciates in value. The following graph describes this foreign exchange market scenario.

The diagram represent the foreign exchange market between the rand and the American dollar. Initially, the market equilibrium is set at point e1, at which the demand curve of rands (D1) and the supply curve of rands (S) interact. Due to the decrease in American tourists to South Africa, the demand curve of rands falls from D1 to D2, and eventually establish a new equilibrium at e2. The price of rand in terms of the American dollar falls from P1 to P2, as shown. Simultaneously, the quantity of rands exchanged fall from Q1 to Q2. This also means that the quantity of the American dollar traded on the foreign exchange market decreases.