The diagram below represents the market for loanable funds and the market for foreign-currency exchange in Mexico. Use the diagram to answer the following questions.Figure 19-7 -Refer to Figure 19-7. Which of the following is consistent with capital flight from Mexico? A)The real exchange rate of the peso appreciates from E₀ to E₁. B)The real exchange rate of the peso depreciates from E₀ to E₁. C)The real exchange rate of the peso appreciates from E₁ to E₀. D)The real exchange rate of the peso depreciates from E₁ to E₀.

Question

Quizplus · Accepted Answer

Capital flight from Mexico would lead to a decrease in the supply of loanable funds, shifting the supply curve to the left from S1 to S2. This would increase the equilibrium interest rate from I1 to I2. As a result, the demand for pesos in the market for foreign-currency exchange would decrease, causing the real exchange rate of the peso to depreciate from E₁ to E₀. Therefore, the correct choice is D.

The Diagram Below Represents the Market for Loanable Funds and the Market