Refer to the above diagram.The initial demand for and supply of pesos are shown by D₁ and S₁.If the decline in Canadian imports from Mexico described in the previous question occurred under a system of flexible exchange rates: A)gold would flow from Mexico to Canada. B)the peso price of dollars would rise from 1/B pesos equals $1 to, 1/A pesos equals $1. C)a problem of rationing a shortage of pesos would arise in Canada. D)the dollar price of pesos would increase to C dollars equals 1 peso.

Question

Quizplus · Accepted Answer

A decline in Canadian imports from Mexico would reduce the demand for pesos and shift the demand curve leftward from D₁ to DS2U1B11S2U1B0. This would lead to a surplus of pesos on the market. Under a flexible exchange rate system, the exchange rate would adjust to clear the market. The excess supply of pesos would put downward pressure on the peso price of dollars, causing it to rise from 1/B pesos equals $1 to 1/A pesos equals $1, where A is greater than B. This would make imports from Mexico cheaper for Canadian consumers and help to stimulate demand for pesos again.

Refer to the Above Diagram