TutorOn by Sanath Withanage

Question:

In a flexible exchange rate system, an increase in foreign demand for domestic goods will
(1) increase demand for the domestic currency, creating a depreciation of the domestic currency.
(2) reduce demand for the domestic currency, creating an appreciation of the domestic currency.
(3) increase demand for the domestic currency, creating an appreciation of the domestic currency.
(4) reduce demand for the domestic currency, creating a depreciation of the domestic currency.
(5) reduce supply of the domestic currency, creating a depreciation of the domestic currency.

Correct Answer:

(3)

Answer Explanation:

When foreigners want to buy more domestic goods (exports increase), they must acquire the domestic currency to pay for them. This increases the demand for the domestic currency in the foreign exchange market, causing its value to rise (appreciate) relative to other currencies.

Topic: Exchange Rates Year: 2022