Derivation of the DD Curve
A DD curve usually plots a GNP, which is at equilibrium, and the possible exchange rate that may prevail at any point in time. As such, any point on this curve represents a value, which is the equilibrium.
The DD curve tends to have a positive gradient. This depicts the rise of Equilibrium GNP as brought about by depreciation of the dollar (Suranovic 285).
Shifting the DD Curve
Increasing investment demand raises the entire demand of the economy resulting in the DD curve shifting to the right. This can only happen if government demand rise, taxes decrease, transfer of payments increases, price levels decrease as well as foreign prices rise.
A decrease in investment decreases the AD and hence the curve moves or curves leftwards. This is possible only when government demand decrease, increase in tax, transfer payments decrease and the price level increase while the foreign level of prices decreases.
Derivation of the AA Curve
An AA curve is used to show an equilibrium exchange rate, concerning every possible gross Net Product that may exist at any time, holding all other factors constant. As such, any point of the curve represents a value of equilibrium in the money- forex market. The reason why the gradient of this curve is negative is that, if the real GNP increases, it decreases the equilibrium exchange rate in this model (Suranovic 292).
Shifting the AA Curve
AA curve shows the relationship between an exogenous and an endogenous variable as they exist in the asset market model.
An increase in the amount of money supplied to increase the AA curve shift upward. As such, a decrease in the level of prices, increase in foreign rates of interests and an increase in the exchange rate also have the same effect on the AA curve. If the opposite occurs, then the AA curve will shift downwards.
Super equilibrium: Combining DD and AA
A super equilibrium is a state, which represents a level of GNP and the rate of exchange values existing at the point of intersection between the DD and AA curves. This intersection depicts the values representing the equilibrium of the G&S Market, Forex market, and the money market. This happens at the same time and hence super equilibrium (Suranovic 297).
Adjustment to the Super equilibrium
When the adjustments Asset market with the G&S market is put into comparison, it is realized that the former experiences adjustments at a higher rate, than the latter. When demand in investment decreases, in an AA-DD model, GNP increases thus rise in the depreciation of the currency.
The foreign rate of interest rise results in an increase in GNP, as well as the rate of exchange and this, still represents a depreciation of the currency.
AA-DD and the Current Account Balance
This situation is represented by the use of an iso-CAB. As such, it is a line, on the diagram representing the AA-DD diagram. Here, several points exist and represent points at which the Current Account Balances are similar. It has a positive gradient though lower than that of the DD curve (Suranovic 301).
To check the extent of change in the CAB from exogenous variables; the iso-CAB line can be used. Here, it must be considered that changes in exogenous variables, which include, p$, p£, TR as well as T are not considered.
Suranovic, Steve. International Finance. New York, NY: Flat World Knowledge, L.L.C. 2010. Print.