Appreciation of the domestic currency will
A) increase domestic aggregate demand.
B) decrease domestic aggregate supply.
C) decrease domestic aggregate demand, and possibly increase domestic aggregate Supply.
D) cause a deterioration in the trade balance, but have no effect on aggregate supply or Demand.

Question

Quizplus · Accepted Answer

Appreciation of the domestic currency will make imports relatively cheaper, leading to a decrease in domestic aggregate demand. At the same time, exports become relatively more expensive, which may lead to a decrease in exports and a decrease in domestic aggregate supply if the country has a relatively high dependence on exports. However, there is also a possibility that the decrease in import costs may lead to an increase in domestic aggregate supply if the country relies heavily on imported inputs for production. So, the answer is C, as it covers both the possible effects of currency appreciation on aggregate demand and supply.

Appreciation of the Domestic Currency Will