Question

32. An external shock such as a foreign country’s devaluation will shift the: a. FE curve...

32. An external shock such as a foreign country’s devaluation will shift the:

a. FE curve to the right.

b. LM curve to the right.

c. FE curve to the left.

d. LM curve to the left.

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Homework Answers

Answer #1

FE line shows the level of output at which labor market is in equilibrium. FE line only shifts left or right when Labor supply decreases or increases respectively.

However, if foreign country devaluates, for them export becomes more competitive and import becomes more expensive because now they will have to spend more to import 1 unit of good. This will decrease their import demand. Decrease in import demand by the foreign country will decrease the money demand for domestic country in the forex market(because, when a country imports goods from domestic country, they pay in domestic country's currency). Reduction in quantity of money demand, reduces the price of money(interest rate) in domestic country. As a result, LM curve shifts to the right.

Answer- option B

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