The graph below shows the supply and demand curves for dollars in the pound/dollar market. Refer to the graph above. Assume that D₁ and S₁ are the initial demand for and supply of dollars. Now suppose that Great Britain increases its imports of American products. Assuming freely floating exchange rates:

Question

Quizplus · Accepted Answer

An increase in Great Britain's imports of American products will increase the demand for dollars (shift the demand curve to the right) and decrease the supply of dollars (shift the supply curve to the left). This will cause the equilibrium exchange rate to rise, meaning the pound price of dollars will increase. Therefore, choice B is correct. Choice A implies a decrease in the exchange rate, which is opposite to the expected outcome. Choice C implies an increase in the dollar price of pounds, which is the opposite of what happens with an increase in demand for dollars. Choice D is incorrect as there is no indication of a shortage of dollars in the question.

The Graph Below Shows the Supply and Demand Curves for Dollars