Refer to the above diagram.The initial demand for and supply of pesos are shown by D₁ and S₁.If the decline in Canadian imports from Mexico described in the previous question occurred under a system of flexible exchange rates: A)gold would flow from Mexico to Canada. B)the peso price of dollars would rise from 1/B pesos equals $1 to, 1/A pesos equals $1. C)a problem of rationing a shortage of pesos would arise in Canada. D)the dollar price of pesos would increase to C dollars equals 1 peso.

Question

Quizplus · Accepted Answer

A decline in Canadian imports from Mexico would result in a decrease in the demand for pesos, shifting the demand curve to the left from DS1U1B11S1U1B0 to DS2U1B11S1U1B0. This would result in a surplus of pesos in the market, causing the peso price of dollars to rise from 1/B pesos equals $1 to 1/A pesos equals $1. This is a typical adjustment mechanism under flexible exchange rates. Option A is incorrect as gold no longer determines exchange rates under a system of flexible exchange rates. Option C is incorrect as surplus of pesos would result in a fall in the peso price of dollars, not a shortage of pesos. Option D is incorrect as the dollar price of pesos would decrease in the situation of a surplus of pesos.

Refer to the Above Diagram