Which of the following events will cause the largest real depreciation for the domestic economy?
A) A 7% decrease in E and a 7% decrease in P*.
B) A 3% increase in E and a 3% increase in P.
C) A 7% increase in P and a 7% decrease in P*.
D) A 7% decrease in E and a 7% increase in P*.
E) A 4% increase in E.

Question

Quizplus · Accepted Answer

A decrease in the exchange rate (E) causes a real depreciation, while an increase in the foreign price level (P*) causes an increase in the relative price of domestic goods and a real depreciation. Therefore, option D, which includes both a decrease in E and an increase in P*, will cause the largest real depreciation for the domestic economy.

Which of the Following Events Will Cause the Largest Real