Figure 19-4
-Refer to Figure 19-4.The equilibrium exchange rate is originally at A,$3/pound.Suppose the British government pegs its currency at $4/pound.Speculators expect that the value of the pound will drop and this shifts the demand curve for pounds to D2.If the government abandons the peg,the equilibrium exchange rate would be

Question

Figure 19-4 
-Refer to Figure 19-4.The equilibrium exchange rate is originally at A,$3/pound.Suppose the British government pegs its currency at $4/pound.Speculators expect that the value of the pound will drop and this shifts the demand curve for pounds to D2.If the government abandons the peg,the equilibrium exchange rate would be

Quizplus · Accepted Answer

When the British government pegs its currency at $4/pound, the equilibrium exchange rate shifts from A to B. However, if speculators expect the value of the pound to drop, the demand curve for pounds will shift to D2. This creates excess supply and puts downward pressure on the exchange rate. Therefore, the equilibrium exchange rate moves to where the demand and supply curves intersect, which is point C, $2/pound. If the government abandons the peg, the exchange rate will adjust to the new equilibrium at $2/pound. Therefore, the answer is C.

Figure 19-4 -Refer to Figure 19-4.The Equilibrium Exchange Rate Is Originally at Is