Under a system of freely flexible (floating)exchange rates an American trade deficit with Mexico will tend to cause

Question

Quizplus · Accepted Answer

Under a system of freely flexible exchange rates, an American trade deficit with Mexico will cause an increase in the demand for pesos as the US needs more pesos to pay for Mexican imports. This increase in demand for pesos relative to the supply of them will lead to an increase in the dollar price of pesos, making American exports to Mexico relatively cheaper and Mexican imports to the US relatively more expensive. This is also known as a depreciation of the dollar against the peso. Therefore, the best choice is D, an increase in the dollar price of pesos.

Under a System of Freely Flexible (Floating)exchange Rates an American