Problem Set on Price Levels and Open Economy Macro Essay

Problem Set on Price Levels and Open Economy Macro - Essay Example 2. When national income rises due to increased payments, imports are likely to increase in value relative to exports and as a result, the external value of the currency will depreciate thus weakening real and nominal exchange rates in the long run. For example, the 1986 fall in the price of oil led to a depreciation of the sterling pound on the foreign-exchange market. On the other hand, a reduction in national income reduces import in value relative to exports the resultant effect being the appreciation of external value of currency thus strengthening real and nominal exchange rates in the long run. 3. Factors such as indirect taxes, subsidies and transport costs may change prices of goods in a country but not affect the exchange rates. If a country imposes tariff on imports from abroad, the price in the home market would rise but since less foreign currency would be spent on it, the long run exchange rate will tend to improve. The long run nominal exchange rate will also improve. 4. Short-term capital moves from one country to another as changes take place in the rate of interest being offered by each country.