Question
Exercise No. 1 (60 points) Suppose an economy for which we know that there is a fixed exchange rate of 1500 diner/$. Explain and graph (IS/LM and money market) what effect it would have on the interest rate if the current exchange rate is 800 diner/$.
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Answer to a math question Exercise No. 1 (60 points) Suppose an economy for which we know that there is a fixed exchange rate of 1500 diner/$. Explain and graph (IS/LM and money market) what effect it would have on the interest rate if the current exchange rate is 800 diner/$.
Dexter
4.7113 Answers
1. **Identify the exchange rate disparity:**
- Fixed exchange rate: 1500 \, \text{diner/}\$
- Current exchange rate: 800 \, \text{diner/}\$
2. **Analyze the impact on the economy's demand:**
- The current exchange rate (800 diner/$) is lower than the fixed rate (1500 diner/$).
- This implies that the domestic currency is undervalued compared to the fixed exchange rate.
3. **Effect on the IS curve:**
- An undervalued domestic currency makes exports cheaper and imports more expensive.
- This leads to increased demand for domestic goods, shifting the IS curve to the right.
4. **Effect on the LM curve and the money market:**
- Higher output and income from increased demand raise the demand for money.
- With the money supply fixed, the increased demand for money raises the interest rate.
5. **Conclusion:**
\text{The interest rate will rise.}
- Fixed exchange rate:
- Current exchange rate:
2. **Analyze the impact on the economy's demand:**
- The current exchange rate (800 diner/$) is lower than the fixed rate (1500 diner/$).
- This implies that the domestic currency is undervalued compared to the fixed exchange rate.
3. **Effect on the IS curve:**
- An undervalued domestic currency makes exports cheaper and imports more expensive.
- This leads to increased demand for domestic goods, shifting the IS curve to the right.
4. **Effect on the LM curve and the money market:**
- Higher output and income from increased demand raise the demand for money.
- With the money supply fixed, the increased demand for money raises the interest rate.
5. **Conclusion:**
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