Assume Indonesia and Australia are major trading partners. If Indonesian incomes rise relative to Australia's, ceteris paribus, we should expect

Question

BlackTom AI · Accepted Answer

Higher Indonesian incomes raise Indonesian demand for imported goods, including Australian exports; that increases demand for Australian dollars and causes the Australian dollar to appreciate.

1) Relevant concepts
- Income effects on trade: when a country’s income rises, its demand for normal goods (including imports) increases.
- Foreign exchange demand: buyers of Australian goods/services must obtain Australian dollars (AUD), so higher foreign demand for Australian exports shifts demand for AUD rightward.
- Ceteris paribus exchange rate adjustment: with demand for AUD up and supply unchanged, the AUD appreciates.

2) Step-by-step reasoning
- Step 1: Indonesian real incomes rise relative to Australia’s (ceteris paribus). Indonesian consumers and firms buy more goods and services.
- Step 2: Part of the increased spending is on imports; because Australia is a major partner, Indonesian demand for Australian exports rises.
- Step 3: To pay Australian exporters Indonesians need AUD. Therefore the demand curve for AUD increases (shifts right).
- Step 4: With supply of AUD unchanged, higher demand bids the price of AUD up — the AUD appreciates relative to the Indonesian currency.

3) Intermediate logic (no numerical calculation required)
- Initial equilibrium exchange rate: E0.
- Demand for AUD shifts right → new equilibrium E1 > E0 (AUD stronger).
- Quantity of Australian exports rises as Australian producers sell more to Indonesia.

4) Why the correct answer is correct
Option b states: an increase in demand for Australian exports, an increase in demand for Australian currency and an appreciation of the Australian currency. That matches the chain above: higher Indonesian incomes → more Australian exports demanded → greater demand for AUD → AUD appreciation.

5) Why other options are incorrect
- a predicts rising demand for Indonesian exports and appreciation of the Indonesian currency — that would occur if Australian incomes rose, not Indonesian incomes.
- c says an increase in demand for Australian imports (ambiguous; if it means Australia’s imports rise, that does not follow from higher Indonesian incomes) and mixes up who demands currency.
- d predicts increased demand for Indonesian exports and increased supply of AUD with AUD depreciation — this is the opposite of the correct directional effects.

Conclusion: Option b is correct — an increase in demand for Australian exports, increased demand for Australian currency, and appreciation of the Australian currency.

Assume Indonesia and Australia are major trading partners. If Indonesian incomes rise relative to Australia's, ceteris paribus, we should expectSingle choice

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