Imagine that the economy is at a point that is below both AA and DD, where both the output and asset markets are out of equilibrium. Which first action is TRUE?
A) The economy will stay at this level in the short run.
B) The exchange rate will first rise to a point on the AA schedule.
C) The exchange rate will first rise to a point on the DD schedule.
D) The AA-DD equilibrium will shift to the position of the economy.
E) The output level will first increase to a position on the DD schedule.

Question

Quizplus · Accepted Answer

In this situation, the exchange rate is out of equilibrium, so it will adjust first to a point on the AA schedule, where the exchange rate is at equilibrium. Once the exchange rate has adjusted, then the output level will adjust to a position on the DD schedule, where the output market is at equilibrium. Therefore, choice B is the correct answer.

Imagine That the Economy Is at a Point That Is