The demand for the Franconian franc in the foreign exchange market equals 14,000 - 3,000e and the supply of francs in the foreign exchange market equals 2,000 + 2,000e, where e is the nominal exchange rate expressed in U.S. dollars per franc. If the franc is fixed at 3 U.S. dollars per franc, then to maintain this fixed rate Franconia's international reserves must:
A)decrease by 9,000 dollars per period
B)increase by 9,000 dollars per period
C)decrease by 3,000 dollars per period
D)increase by 3,000 dollars per period

Question

Quizplus · Accepted Answer

At the official fixed exchange rate of 3 U.S. dollars per franc, the demand for the franc is 14,000 - 3,000(3)= 5,000 and the supply of franc is 2,000 + 2,000(3)= 8,000. To maintain this overvalued fixed rate, the Franconian governments must purchase the excess 3,000 (8,000 - 5,000)franc by spending down or decrease their international reserves by 3,000 francs each period. At the fixed exchange rate of 3 U.S. dollars per franc, that is 9,000 dollars (3,000 × $3).

The Demand for the Franconian Franc in the Foreign Exchange