The effect of an exchange rate system on the price level between countries is that:
A) exchange rate volatility causes the prices to converge between countries.
B) a fixed exchange rate results in price convergence.
C) a fixed exchange rate results in price divergence.
D) all member nations of the ERM saw a divergence in prices.

Question

Quizplus · Accepted Answer

A fixed exchange rate system leads to price convergence between countries as it eliminates the uncertainty associated with fluctuating exchange rates. This encourages businesses to trade and invest in the partner countries, leading to increased competition and efficiency, which ultimately results in price convergence. Exchange rate volatility, on the other hand, can result in price divergence between countries as businesses factor in the risk and uncertainty associated with varying exchange rates when setting prices. The ERM (European Exchange Rate Mechanism) is no longer in use and did not involve all countries, so option D is incorrect.

The Effect of an Exchange Rate System on the Price