The figure given below illustrates the market for British pounds. D_£ and S_£ are the demand and supply curves of the British pounds respectively. If the exchange rate is pegged at $2.50 per pound::

Question

Quizplus · Accepted Answer

If the exchange rate is pegged at $2.50 per pound, it means that the market is not allowed to determine the exchange rate based on supply and demand. If the demand and supply curves are as shown in the figure, the equilibrium exchange rate should be at point E, which is higher than $2.50. This means that the pound is overvalued at $2.50 and it would be difficult for British exporters to compete in the US market. Additionally, it implies that US goods would be relatively cheaper in the British market, leading to a fall in the demand for American goods in the British market.

The Figure Given Below Illustrates the Market for British Pounds