Answer to Question #251613 in Microeconomics for noxolo

Question

Explain, with the aid of a graph, what will happen to the rand/dollar exchange rate and the equilibrium quantity of dollars if South African exports to the United States increase. (Hint: In your answer, also comment on the effect on the current account of the balance of payments as well as on the level of domestic prices.)

Answer 1

Solution:

If South African exports to the United States increase, this means that there is a high demand for its goods, and thus its currency. When the demand is high, domestic prices will rise and the South African rand will appreciate in value.

The demand curve for rand will shift to the right from D to D₁, due to an increase in the quantity demanded from Q to Q₁ and push up the exchange rate of the rand against the US dollars from R to R₁.

 

This is depicted by the below graph:

 

There will be a surplus in the current account balance of payments since it will be positive. This means that South Africa has more exports than imports of goods and services. If a country’s exports increase by a greater rate than its imports, its terms of trade are improved favorably due to a rise in exports revenues.