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 2 U.S. dollars per franc, then to maintain this fixed rate Franconia's international reserves must:
A)decrease by 2,000 dollars per period.
B)decrease by 4,000 dollars per period.
C)increase by 4,000 dollars per period.
D)increase by 2,000 dollars per period.

Question

Quizplus · Accepted Answer

At the official fixed exchange rate of 2 U.S. dollars per franc, the demand for the franc is 14,000 - 3,000(2)= 8,000 and the supply of franc is 2,000 + 2,000(2)= 6,000. To maintain this undervalued fixed rate, the Franconian governments must supply this shortage of 2,000 franc each period by purchasing international reserves. At the fixed exchange rate of 2 U.S. dollars per franc, that is an increase in international reserves by 4,000 dollars (2,000 × $2)per time period.

The Demand for the Franconian Franc in the Foreign Exchange