The figure given below illustrates the market for British pounds. D_£ and S_£ are the demand and supply curves of the British pounds respectively. Suppose initially the exchange rate is pegged at $2.50 per pound. If the governments allow the pound to float, the pound will experience a(n):

Question

Quizplus · Accepted Answer

When the government allows the pound to float, the exchange rate will be determined by the market forces of demand and supply. The supply of pounds will increase due to the floating rate system, causing the supply curve to shift to the right from S_£ to SS2U1B1£S2U1B0. The new equilibrium exchange rate will be lower than the initial pegged rate, causing a depreciation of the pound. Therefore, the correct answer is D) depreciation.

The Figure Given Below Illustrates the Market for British Pounds