Paper Two, Topic A
If the European Union develops new technology that lowers the costs of producing goods that they export, the opportunity cost of producing decreases, and they can increase the amount of goods that they supply. As a result, the new quantity supplied would be higher than the quantity demanded, a surplus would form, and the two markets will move into equilibrium where the price level is lower and the quantity supplied is greater than before. An overall lower price of goods in the European Union will increase domestic and foreign demand for their products. Citizens in the EU will substitute more expensive foreign goods for domestic goods and the quantity demanded for domestic goods will increase. Exports for the EU will increase, as ...view middle of the document...
In return, banks will begin to increase interest rates on investment, making European financial assets more attractive to investors. The increased demand for European money on account of the increase in real GDP, the increase of foreign demand for European goods, and the higher benefits of investing in Europe will cause the euro to appreciate relative to the rest of the world. This means that the euro is worth more than it was previously, and has more buying power than it did before its appreciation. Now, the exchange rates for the European union will increase. It now costs more for a foreign currency to purchase something in Europe than it did previously. The increase of the euro is allowed because of the increased demand for European goods and assets, and the increased benefits of investing in Europe. The spur of investment in European financial accounts will increase the financial account balance of the European Union.
The European Union now has more foreign investing power due to their stronger currency. As they increase their foreign investments, their balance of payments will decrease as funds flow out of the country. Now that it costs more for foreign countries to invest in Europe, investment will decline, further decreasing the financial account. Because of an initial increase in the financial account and then a delayed decrease, it is indeterminate how an initial decrease in production costs in Europe will impact the financial account. Europe will also start importing more because their stronger currency allows them to buy more foreign goods for less money. European exports will begin to decrease as they are now more expensive to foreign consumers. This new combination will decrease net exports, and decrease the balance of trade, making its final value undetermined.