Figure 30-8
-Refer to Figure 30-8.The equilibrium exchange rate is originally at A,$1.25/euro.Suppose the European Central Bank pegs its currency at $1.00/euro.Speculators expect that the value of the euro will rise and this shifts the demand curve for euro to D2.If the European Central Bank abandons the peg,the equilibrium exchange rate would be

Question

Figure 30-8 
-Refer to Figure 30-8.The equilibrium exchange rate is originally at A,$1.25/euro.Suppose the European Central Bank pegs its currency at $1.00/euro.Speculators expect that the value of the euro will rise and this shifts the demand curve for euro to D2.If the European Central Bank abandons the peg,the equilibrium exchange rate would be

Quizplus · Accepted Answer

When the European Central Bank pegs its currency at $1.00/euro, it means that it is buying and selling euro at that rate. This leads to an excess supply of euro at the original equilibrium exchange rate of $1.25/euro (point A), which shifts the demand curve for euro to the right to D2. This causes the exchange rate to appreciate and reach a new equilibrium point at C, where the demand and supply of euro are equal at a rate of $1.50/euro. Therefore, if the European Central Bank abandons the peg, the new equilibrium exchange rate would be $1.50/euro.

Figure 30-8 -Refer to Figure 30-8.The Equilibrium Exchange Rate Is Originally at Is