Answer to Question #98128 in Macroeconomics for iqra illyas

Question

1-Use the model of the foreign exchange market to explain the relatively high value of the Australian dollar
2- Describe the adjustment to long run equilibrium if an economy experiences a
negative aggregate demand shock and the short run equilibrium output is below
potential output.

Answer 1

1. The Australian dollar`s persistent strength owes a lot to the elevated level of commodity prices and relatively high interest rates in the Australian economy. Therefore, in the foreign exchange market the Australian dollar high value reflects the on-going weakness of the US dollar.

2. In the long-run the shock would be corrected by rising labor costs which will in turn increase workers wages. The level of inflation will then reduce as a result. Output decreases and price levels increases until real GDP returns to full employment output.