I'm in AP (high school) Macroeconomics and I confirm if my thinking is right. Suppose the US and Taiwan are trading, and the US government decides to decrease taxes. I think this should have two effects on the foreign exchange market between USD and TWD (Taiwanese dollars).

  1. Lower taxes means US consumers have more disposable income, i.e. relative income of US consumers is higher. They demand more foreign Taiwanese goods since they have become relatively cheaper. Thus $S_\textrm{USD}$ should shift to the right, since more US consumers are putting their USD up to exchange for TWD, and $D_\textrm{TWD}$ should shift right as well.

  2. Greater relative income in the US means lower relative income in Taiwan. Taiwanese consumers find it more expensive to import US goods, so they decrease the supply of TWD they put up in the forex market (they are less willing to exchange and buy US goods), so $S_\textrm{TWD}$ should shift to the left. Further $D_\textrm{USD}$ shifts to the left as well.

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While these two effects have an indeterminate effect on the quantity of currency in their respective forex markets, they have a determinate effect on exchange rates. The USD depreciates and TWD appreciates. So the US finds it more expensive to import and so US imports decrease, while US goods become cheaper to foreigners and so US exports increase. Thus US's GDP increases and price levels increase. I've been taught that only one of the two shifts occurs. Is this 2-shift conceptualization correct?

Would this also mean that initially, US consumers look towards Taiwan to buy goods (they have more disposable income) but after exchange rates adjust, they stop (since US imports decrease)?


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