2.1 The exchange rate between the U.S. dollar and the Japanese yen is floating freely - both governments do not intervene in the market for each currency. Suppose a large trade deficit with Japan prompts the United states to impose quotas on certain Japanese products imported into the United States and as a result the quantity of those imports falls.

a. The decrease in spending on Japanese product increases spending on the U.S. - made goods. Why? What effect will this have on the U.S. output and employment and on Japanese output and employment?

b. What happens to U.S. imports from Japan when US output or income rises? If the quotas initially reduce imports from Japan by $25 million, why is the final reduction in imports likely to be less than $25 billion?

c. Suppose the quotas do succeed in reducing imports from Japan by $15 million. What will happen to the demand for yen? Why?

d. Considering the macroeconomic effects of a quota on Japanese imports, could a quota reduce employment and output in the United states? Could it have no effect at all? Explain.

3.6 The exchange rate between the U.S. dollar and the British pound is a floating rate, with no government intervention. If a large trade deficit with Great Britain prompts the United states to impose quotas on certain British imports, resulting in a reduction in the quantity of these imports, what will happen to the dollar - pound exchange rate? Why? (Hint: there is an excess supply of pounds, or an excess demand for dollars.) What effects will the change in the value of each currency have on employment and output in the United states? What about the balance of trade? (Ignore complications such as the J curve.)