The figure given below depicts the equilibrium exchange rate between the U.S dollar and the Mexican peso. Figure 13.2 Refer to Figure 13.2.Given a target exchange rate of MXP 11 = $1 with S₁ the relevant supply curve and a decline in Mexican demand for U.S.dollars from D₁ to D₂ the Fed intervenes in the foreign exchange market by: A)selling Q₃ amount of pesos. B)selling Q₃ amount of U.S.dollars. C)buying (Q₂ - Q₁)amount of pesos. D)buying (Q₁ - Q₃)amount of U.S.dollars. E)buying (Q₂ - Q₃)amount of U.S dollars.

Question

Quizplus · Accepted Answer

If there is a decline in Mexican demand for U.S. dollars, the exchange rate would shift to the left from S₁ to S₃. To maintain the target exchange rate of MXP 11 = $1, the Fed needs to intervene by buying U.S. dollars. The Fed should buy (Q₁ - Q₃) amount of U.S. dollars to shift the exchange rate back to the target rate. Therefore, choice D is correct, and the Fed should buy (Q₁ - Q₃) amount of U.S. dollars.

The Figure Given Below Depicts the Equilibrium Exchange Rate Between