[Anonymous]

A company manufactures goods in Esland for sale to consumers in Woostland. Currently, the economy of Esland is booming and imports are rising rapidly.

Woostland is experiencing an economic recession and its imports are declining.

How will the Esland currency, $E, react with respect to the Woostland currency, $W?

A. The $E will remain constant with respect to the $W.

B. The $E will increase with respect to the $W.

C. The $E will decline with respect to the $W.

D. Changes in imports and exports will not affect currency changes.

Answer: C. The $E will decline with respect to the $W.

Long/confusing pubisher explanation: In a flexible or floating foreign currency exchange rate system, the equilibrium rate of exchange between currencies is determined by market supply of and demand for each currency. Because Esland’s import of goods is rising rapidly, Esland’s demand for foreign currencies, including Woostland currency, will increase. Conversely, because Woostland’s imports are declining, there is a decreasing demand in Woostland for foreign currencies, including Esland’s currency. As a consequence of Esland’s relative increased demand for Woostland’s currency, more units of Estland’s currency will be required to purchase each unit of Woostland currency. Since it takes more units of $E to purchase each unit of $W, the value of $E relative to $W declines.

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If E is doing well compared to W, which is doing poorly, why would E decline?

[Anonymous]

E would decline because there is no one to buy their exports in W, so they have all these exports and no one to sell them to. Therefore, they are going to decline with money going out but nothing coming in.

[Never_Give_Up1]

It is C. When an economy is in decline it means that is weak, if the economy is weak there is less of the money going around the economy. If W is not purchasing the items from E because their economy is down, what need would E have for W's currency? Thus the demand or “need” for the currency would drop but the supply of paper $$$ is still constant unless the central bank sells bonds to reduce the money supply.

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