Under flexible exchange rate, the response of an economy to a temporary fall in foreign demand for its exports is
A) the currency appreciates, and output falls.
B) the currency depreciates, and output falls.
C) the currency depreciates, and output increases.
D) the currency depreciates, and output remains constant.
E) the currency appreciates, and output increases.

Question

Quizplus · Accepted Answer

Under a flexible exchange rate, a temporary fall in foreign demand for exports leads to a decrease in demand for the domestic currency, causing the currency to depreciate. The depreciation makes the domestic goods cheaper, which leads to an increase in demand for domestic goods and services. However, output falls due to the fall in demand for exports.

Under Flexible Exchange Rate, the Response of an Economy to a Temporary