Recession Abroad
The question
Assume the foreign exchange market for the US dollar is initially in equilibrium. A severe recession in Canada causes Canadian households and firms to sharply reduce their purchases of goods produced in the United States. Show the effect in the foreign exchange market for the US dollar, holding all else constant. Show the effect on the Foreign Exchange Market (USD) graph.
Drag a curve, or use the arrow buttons. Want the free-play version with every control? Open this graph in the sandbox.
Recession Abroad: the worked answer
On the Foreign Exchange Market (USD) graph, Demand for dollars (D$) shifts left.
Why Demand for dollars (D$) shifts left
Canadian buyers must exchange Canadian dollars for US dollars in order to purchase US-made goods. When the recession cuts those purchases, foreigners need fewer dollars at every exchange rate, so the demand for dollars shifts left. American spending on foreign goods and assets is unchanged, so the supply of dollars does not move.
What happens to the equilibrium
The dollar depreciates and the equilibrium quantity of dollars traded decreases.
The mistake students make on this one
The most common wrong answer is shifting the supply of dollars left, on the reasoning that fewer US exports means fewer dollars changing hands. US exports are paid for by foreigners who must buy dollars first, so a drop in exports is a decrease in the demand for dollars; S$ tracks Americans selling dollars, and nothing here changed what Americans buy abroad.
On exam day
Foreign income is a determinant of D$ and domestic income is a determinant of S$. A recession abroad cuts US exports and shifts D$ left, while a recession at home cuts US imports and shifts S$ left, and the two move the exchange rate in opposite directions.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when Demand for dollars (D$) shifts left and every other curve on the Foreign Exchange Market (USD) graph stays where it started — the same standard an AP reader applies to a drawn graph: the right shift, and nothing extra. There is no AI involved; the rubric is the geometry.
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