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    The Dollar demand relative to the Pound

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    Let the exchange rate be defined as the number of dollars per British pound. Assume there is an increase in U.S. interest rates relative to that of Britain.

    a) Would this event cause the demand for the dollar to increase or decrease relative to the demand for the pound?

    b) Has the dollar appreciated or depreciated in value relative to the pound?

    c) Does this change in the value of the dollar make imports cheaper or more expensive for Americans? Are American exports cheaper or more expensive for importers of U.S. goods in Great Britain? Illustrate by showing the price of a U.S. cell phone in Britain, before and after the change in the exchange rate.

    d) If you had a business exporting goods to Britain, and U.S. interest rates rose as they have in this example, would you plan to expand production or cut back?

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    Solution Preview

    For simplicity, we should assume that there are only two countries, US and UK. The resp. currencies are USD and GBP.

    Given that US interest rate goes up => UK investors would prefer saving in US rather than UK (since the interest rate in UK didn't go up) => increase in demand for USD => UK investors ...

    Solution Summary

    The Dollar demand relative to the Pound; value of imports and exports