4.5(Global)Exchange rates,Pt2:Consequences exchange rate (appreciation,revaluation) macro indicators

Video tutorial illustrating how to connect Global Economy to Macro to address consequences of changes in the exchange rate on economic indicators such as inflation, real GDP, unemployment, and living standards.

Direct link to video regarding consequences of a depreciation (revaluation) on macro indicators:
   • 4.5(Global)Exchange rates,Pt1:Consequ...  

The factor applied regarding the rise in demand for the Japanese Yen (appreciation) is the export promotion trade policies of Japan in the post World War 2 period, which led to rising demand by US consumers for Japanese exports (and thus the Japanese currency)

Note:
IB Econ analysis of the FOREX market for Japanese Yen (time 3:12)
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Graph A: Market for Japanese Yen in the foreign exchange rate system (FOREX)
X-axis measures quantity supplied & demanded of Japanese Yen
Y-axis measures the value of the Japanese Yen in terms of US dollars (US Dollars per Japanese Yen)

There are two downward sloping demand curves (law of demand) labelled D1 Yen, D2 Yen
There is one upward sloping supply curve (law of supply), S1 Yen

In the FOREX, where S1 Yen = D1 Yen an equilibrium exchange rate is set at E1 (point A), at Q1, (Qs=Qd)
E1 = (1 Japanese Yen = 0.004 USD)

The following provides background information
Japan in the post World War 2 period pursued export promotion policies as a means to generate enough revenue from exports to cover the cost of needed inputed resources. Under government guidance and support the export sector of the Japanese economy was developed and protected via trade protectionist policies, which included administrative barriers. These policies enabled Japan to develop a trade surplus with the US where exports to the US exceeded imports; thus leading to rising demand by US consumers for Japanese exports, thus rising demand for the Japanese Yen (appreciation)

Increased demand for the Japanese Yen by US consumers demanding Japanese exports led to D1 Yen shifting to D2 Yen
Excess demand of Yen places upward pressure on the Yen exchange rate value
The Japanese Yen appreciates to E2
As the Japanese Yen appreciates, Qs increases from Q1 (Point A) to Q2 (Point B)

Where D2 Yen = S1 Yen, a new equilibrium is established
E2 (1 Japanese Yen = 0.008 USD)
Q2, (Qs=Qd) (Point B)
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IB Econ Paper analysis of the consequences of an appreciation (or revaluation) on economic indicators (deflation) 5:13
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Graph B: Deflation (imported deflation)
X-axis measures real GDP
Y-axis measures price level (PL)

Aggregate Demand 1 = AD1 = C+I+G+(X-M)
Short Run Aggregate Supply 1 = SRAS1

SRAS1=AD1 (point A), provides the equilibrium PL at PL1 & equilibrium real GDP at Y1

The appreciation of the Japanese Yen leads to imported inputs & outputs, which are components of Japan's SRAS curve, to be cheaper (the stronger purchasing power of the Japanese Yen make, for example, US imported inputs & outputs cheaper)

As a result of reduced costs of imported inputs & outputs the SRAS1 curve shifts outwards to SRAS2

AD1=SRAS2 (point D), provides a short-run equilibrium PL at PL2 & equilibrium real GDP at Y2
An increase in SRAS leads to an increase in the quantity of AD (as a result of the fall in PL) from point C to point D (along AD1) thus firms begin to employ more resources such as labor, land, & capital (this is occurring in the sector of the domestic economy that is dependent on the sale of imported inputs and outputs)

Unemployment decreases at Y2
A decrease in the price level from PL1 to PL2 along with increasing real GDP (Y1 to Y2) signals deflation, but rising GDP
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IB Econ Paper analysis of the consequences of an appreciation (or revaluation) on economic indicators (deflationary gap) 8:29
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Graph C: Deflationary gap
SRAS1=AD1 (point E), provides equilibrium PL at PL3 & equilibrium real GDP at Y3

The appreciation of the Japanese Yen leads to an increase in domestic demand for the increasingly cheaper imported necessities and luxuries while in the long run exports become the relatively more expensive substitute to foreign nations in the global market
Thus exports (X) decrease while imports (M) rise
Thus the (X-M) component of AD causes AD to decrease to AD2

AD2=SRAS1 (point F), provides a short-run equilibrium PL at PL4 & equilibrium real GDP at Y4
A decrease in AD leads to a decrease in the quantity of SRAS from point E to point F (along SRAS1) thus firms in the export sector of the Japanese economy unemploy (fire) resources such as labor, land, & capital (again, this is occurring in the export sector of the domestic economy)
Unemployment increases at Y4
A decrease in PL from PL3 to PL4 along with decreasing real GDP (Y3 to Y4) signals a deflationary gap