Exercise on International Economics

Prepared by Dr. Ly Dai Hung1

Equilibrium Exchange Rate

Assume that the world economy has two countries: Vietnam and United States. Each
country has its own currency: VND in Vietnam and USD in United States.
When a politician says that the bubble in housing market in Vietnam is going to
explore, this news will result in a withdraw of foreign investment from Vietnam to
United States. At the same time, the foreign investors also need to convert VND into
USD to take their income to United States.
Câu hỏi 1. How does this event affect the equilibrium VND/USD exchange rate?
Let’s answer the question by two parts:
A Model.
Define (e = V N D/U SD) as the exchange rate and q as the quantity of foreign
currency (USD). The equation for supply of USD is: e = a+b.q and the equation
for demand of USD: e = c − d.q.

1. Define the value (negative or positive) of parameters (b, d)? Explain the
reasons.
2. Set up the system of equations, then solve for the equilibrium exchange rate
and quantity of USD, denoted by (e0 , q0 ). Hint: Rewrite the two equations
so that the quantity is a function of exchange rate (e). Then, note that the
equilibrium point is based on the equality of supply and demand.
3. Examine whether the event affects the supply or the demand of USD ?
Assume that the quantity of USD that the foreign investors withdraw has
a value of (h) in USD unit. Examine whether (h) is negative or positive?
4. Set up the new system of equations, and solves for the new equilibrium,
denoted by (e1 , q1 ).
1
Email: hunglydai@gmail.com.

1
 5. Compare (e1 , q 1 ) with (e0 , q 0 ). Does the VND appreciate or depreciate?

B Graph.
Let’s employ a two-way graph with the exchange rate (e = V N D/U SD) on the
y-axis, and the quantity of USD in millions in the x-axis.

1. Draw the supply and demand for USD, then, determine the initial equilib-
rium (e0 , q 0 ).
2. Determine whether the event causes the supply or demand curve? and
whether it causes a movement along the curve or movement of the curve?
3. Determine the new equilibrium (e1 , q 1 ) and compare it with the initial
equilibrium (e0 , q 0 ).
4. Does the VND appreciate or depreciate?