[Biff-1955-Tannen]

Can somebody please explain this to me as if you were explaining it to a 5 year old? I don’t understand why E is declining with respect to W. I thought E would have increased with respect to W…

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. <— Correct

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

I don’t understand why a country with a crap economy would have currency with more value than a country with a booming economy. Especially since…

“Political and economic environment—Currencies of countries that are politically stable and economically strong are more desirable than the currencies of countries with political turmoil and a risky economic environment. For example, investors are more likely to make investments in a politically stable country with a history of strong economic performance than a country with political unrest and a fragile economy. Consequently, there will be greater demand for the currency of the better political and economic environment.”

This is the explanation the answer gave:

“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.”

AUD - 93
BEC - 83
FAR - 83
REG - 84

Nobody calls me chicken

AUD 93 Jan 16
BEC 83 Feb 16
FAR 83 Apr 16
REG 84 May 16

99% Ninja MCQ only

[tuanxn]

I got this problem wrong when I first approached it too. I think a better way to look at the question is… What direction will each currency now move? Since W has a crap economy and E a booming economy, E can buy more goods in W. To do so E will have to buy W currency to buy W's goods. This will increase the demand for W's currency, raising the value of W's currency. In contrast, E's currency will decline since its goods are more expensive now and thus a lower demand for the currency will result.

E's currency declines while W's currency appreciates.

[Biff-1955-Tannen]

Thanks for the response. I think you're right. This question is just blowing my mind, I really hope there aren't many like this on the exam…

AUD - 93
BEC - 83
FAR - 83
REG - 84

Nobody calls me chicken

AUD 93 Jan 16
BEC 83 Feb 16
FAR 83 Apr 16
REG 84 May 16

99% Ninja MCQ only

[Anonymous]

Thanks for the explanation! I got this wrong too and was searching the forum for assistance when I found this.

Do NOT quit! There's more in you and if you quit you'll never see it. Show you that you can do it.

AUD Passed  78
BEC Passed  79
FAR Passed  77
REG Passed 76

I'm tired of operating in fear and mediocrity. It's time to try. It's time to do. It's time to go.

[Author]

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