The figure given below depicts the foreign exchange market for British pounds traded for U.S. dollars.
Figure 21.2

-Refer to Figure 21.2. Suppose the British central bank is committed to maintaining an exchange rate of £1 = $1.50, but there is a permanent shift in supply from S1 to S3. According to the Bretton Woods agreement:
A) the pound should be devalued.
B) the dollar should be devalued.
C) the British central bank should buy pounds in exchange for dollars.
D) the British central bank should encourage speculation.
E) the Fed should intervene to maintain the exchange rate of £1 = $1.

Question

The figure given below depicts the foreign exchange market for British pounds traded for U.S. dollars.
Figure 21.2
 
-Refer to Figure 21.2. Suppose the British central bank is committed to maintaining an exchange rate of £1 = $1.50, but there is a permanent shift in supply from S1 to S3. According to the Bretton Woods agreement:
A) the pound should be devalued. 
B) the dollar should be devalued. 
C) the British central bank should buy pounds in exchange for dollars. 
D) the British central bank should encourage speculation. 
E) the Fed should intervene to maintain the exchange rate of £1 = $1.

Quizplus · Accepted Answer

The permanent shift in supply from S1 to S3 leads to an excess supply of pounds, which causes the pound to depreciate in value. To maintain the fixed exchange rate of £1 = $1.50, the British central bank needs to devalue the pound by reducing the official exchange rate. Therefore, the correct choice is A.

The Figure Given Below Depicts the Foreign Exchange Market for British