In the Mundell-Fleming model, if the price level falls, then the equilibrium income
A) rises and the real exchange rate appreciates.
B) rises and the real exchange rate depreciates.
C) falls and the real exchange rate appreciates.
D) falls and the real exchange rate depreciates.

Question

Quizplus · Accepted Answer

According to the Mundell-Fleming model, a fall in the price level increases the real money supply, which in turn reduces interest rates and leads to an increase in investment and consumption. This increase in aggregate demand causes an increase in output and income, which leads to an appreciation of the real exchange rate. Therefore, the correct answer is B – equilibrium income rises and the real exchange rate depreciates.

In the Mundell-Fleming Model, If the Price Level Falls, Then