Exercise 1
Suppose that the central bank of the US increases the interest rate in the US from 1% to 3% while the European central bank maintains its interest rate at 0.5%. Answer the following questions. Justify your answer using diagrams and the concepts developed in chapter 14 of the lecture notes.No numbers are required.
a) What happens to net capital inflows to the US and net capital outflows out of the US?
b) What should happen to the exchange rate of the US dollar in terms of the Euro, the European money? Use the demand and supply model to answer this question.
c) What happens to US exports, imports and trade balance?
d) Is it better to have a fixed exchange rate or a flexible exchange rate? Briefly explain your choice.
Exercise 2 optional no credit
Read the following article. Answer the following questions. Justify your answer.
a) Is $18000 an equilibrium price for the VW Beetle car with all the option? Draw an example of a demand curve and a supply curve for the VW Bug and locate the equilibrium price relative to $18000.
b) Show the effect of an increase in the quantity supplied (to 64,000 cars) in the graph above. What happens to the equilibrium price?
c) If tastes for the VW Bug rise even further, what will happen to equilibrium price and quantity?
d) Suppose a competitor auto company decides to manufacture a car to compete with the VW Bug. If consumers begin to purchase the new car, what will happen to the demand curve for the VW Bug?
e) Suppose that the VW manufacturing plant workers demand and get 25% raises in compensation. Will the demand curve or supply curve be affected in the US? What would you expect to happen to the sticker price?
SHORTAGE OF VOLKSWAGEN BEETLES
The new Volkswagen Beetle has such appeal that many people are willing to pay much more than the sticker price in order to get one. The base model starts at $15,200 and the car with all the options costs about $18,000. Yet, a few days after Wally Leach paid $18,000 for his new VW, a man stopped him in the parking lot with an offer of $27,000. And this was only a few hours after someone had offered him $23,000. Are people crazy?
Actually, the problem is that with demand so great and supply so small, scalping has occurred. Although the Volkswagen Company discourages its dealers from selling at above-sticker prices, some VW dealers just can't turn down the extra profits. In addition, some non-VW dealers are buying them and then re-selling at a tremendous mark-up (even though the customers lose out on the 10-year, 100,000-warranty). Why the tremendous demand? Ronald Pogue of Berkeley says that the car is "cool" and gets him attention wherever he goes. Other owners claim the Bug is the "worst car around."
How do dealers handle the shortage? One dealer in Livonia, Michigan says he has a policy of no waiting lists: for him, it's first-come, first-served. However, some of the customers "are pretty nasty people" and have gotten loud angry when they've been told the cars were already sold. Another dealer in Knoxville, Tennessee, argues that a waiting list is the best way to determine who gets the cars. He currently has a list of 250 people, which translates into an average 18 month wait.
Why the small supply? Before Volkswagen geared up to mass produce the Bug, they wanted to be sure of demand. Thus, they were set to distribute only 50,000 to the US and Canada for this model year. In response to the high demand, next year they will produce 64,000. As the amount supplied rises, the hope is that scalping will eventually stop.