Refer to the diagram below where D and S are Canada's demand for and supply of pesos. At the equilibrium exchange rate, E, Canada's balance of payments is in equilibrium. Under a system of flexible exchange rates, the shift in demand from D₁ to D₂ will:

Question

Quizplus · Accepted Answer

The shift in demand from D₁ to D₂ will cause an increase in the exchange rate, resulting in a depreciation of the peso. This will make Canadian exports cheaper and more attractive to foreign buyers, leading to an increase in exports. At the same time, the higher exchange rate will make imports more expensive, leading to a decrease in imports. Therefore, the shift in demand will improve Canada's balance of payments.

Refer to the Diagram Below Where D and S Are