Use the following diagram to answer the following questions.

-Refer to Diagram 18-1. Suppose that the demand for dollars is initially represented by D₁ and the supply of dollars is represented by S₂. If the inflation rate were to decrease, the effect would:

Question

Use the following diagram to answer the following questions.
 
-Refer to Diagram 18-1. Suppose that the demand for dollars is initially represented by D₁ and the supply of dollars is represented by S₂. If the inflation rate were to decrease, the effect would:

Quizplus · Accepted Answer

If the inflation rate were to decrease, it would lead to an increase in the demand for dollars as it increases the purchasing power of the currency. Hence, the demand curve for dollars would shift to the right from D₁ to D₂. At the same time, the decrease in inflation would lead to a decrease in the supply of dollars in the foreign exchange market as there would be a lesser need to print more money to tackle inflation. Hence, the supply curve for dollars would shift to the left from S₂ to S₁. The intersection of the new demand and supply curves would lead to a new equilibrium exchange rate, which would be higher than the initial exchange rate, i.e., E₄.

Use the Following Diagram to Answer the Following Questions