Treasury Inflow, Import Surge
The question
Assume the foreign exchange market for the US dollar is initially in equilibrium. A sovereign wealth fund in the fictional country of Kessia announces it will hold a much larger share of its portfolio in US Treasury bonds and begins buying them. At the same time, several foreign electronics makers release popular new product lines, and US households sharply increase their purchases of those imported devices. Show the effect of these two changes 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.
Treasury Inflow, Import Surge: the worked answer
On the Foreign Exchange Market (USD) graph, Demand for dollars (D$) shifts right and Supply of dollars (S$) shifts right.
Why Demand for dollars (D$) shifts right and Supply of dollars (S$) shifts right
The Kessian fund must exchange Kessian currency for dollars before it can buy US Treasury bonds, so foreigners want more dollars at every exchange rate and the demand for dollars shifts right. US households buying imported devices must exchange dollars for foreign currency to pay for them, so more dollars are offered for sale at every exchange rate and the supply of dollars shifts right. Both shifts raise the volume of currency changing hands, so the equilibrium quantity of dollars traded definitely increases. The two shifts push the value of the dollar in opposite directions, so the exchange rate is indeterminate: the dollar appreciates if the increase in demand is larger, depreciates if the increase in supply is larger, and is unchanged if the two shifts are equal in size.
What happens to the equilibrium
The equilibrium quantity of dollars traded definitely increases, while the value of the dollar is indeterminate and depends on which of the two shifts is larger.
The mistake students make on this one
The frequent error is calling both outcomes determinate and concluding the dollar appreciates because the stem opens with foreigners buying US bonds. The import surge pushes the dollar the other way, so without a statement about which shift is larger only the quantity of dollars traded can be signed; a related mistake is drawing the second shift as a movement along the supply curve rather than a shift of it.
On exam day
When both curves shift the same direction on the foreign exchange graph, the quantity of dollars traded moves that way for certain and the exchange rate is the variable you must label indeterminate.
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$) shifts right and Supply of dollars (S$) shifts right 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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