When the exchange rate is determined by market forces and an economy is experiencing a net inflow of capital, the economy will tend to
A) run a budget deficit.
B) run a trade deficit.
C) experience an increase in the supply of money.
D) experience a reduction in the supply of money.

Question

Quizplus · Accepted Answer

When an economy is experiencing a net inflow of capital, it means that more foreign capital is entering the country than leaving it. This increase in foreign capital can lead to an increase in demand for the domestic currency, causing the exchange rate to appreciate. A higher exchange rate makes exports more expensive and imports cheaper, which can result in a trade deficit as domestic producers find it harder to compete with cheaper imports. Therefore, choice B is the correct answer. A budget deficit or an increase/decrease in the supply of money are not necessarily related to a net inflow of capital.

When the Exchange Rate Is Determined by Market Forces and an Economy