Which one of the following statements is the most accurate?
A) An increase in the real exchange rate and an increase in disposable income improve the current account.
B) A decrease in the real exchange rate and a decrease in disposable income improve the current account.
C) A decrease in the real exchange rate and a increase in disposable income improve the current account.
D) An increase in the real exchange rate and a decrease in disposable income improve the current account.
E) An increase in the real exchange rate and a decrease in disposable income lowers the current account.

Question

Quizplus · Accepted Answer

An increase in the real exchange rate means that the domestic currency becomes more valuable relative to foreign currencies. This makes imports cheaper, while making exports more expensive. Therefore, an increase in the real exchange rate tends to worsen the current account balance. However, a decrease in disposable income reduces demand for imports, as consumers have less money to spend on foreign goods. Therefore, a decrease in disposable income tends to improve the current account balance. Combining these two effects, we can see that an increase in the real exchange rate and a decrease in disposable income would both work to improve the current account balance.

Which One of the Following Statements Is the Most Accurate