Question

10. Assume exchange rates are flexible. When the quality of one country's products is improving more rapidly than the quality of the products produced in the rest of the world, there will be a tendency, ceteris paribus, for

		A) the country's interest rates to rise relative to the rest of the world.
		B) that country's currency to appreciate.
		C) short term capital to flow out of the country.
		D) the country's inflation rate to rise relative to the rest of the world.
		E) that country's currency to depreciate.

Answer 1

Since the exchange rates are flexible. When the quality of one country's products is improving more rapidly than the quality of the products produced in the rest of the world, there will be a tendency, ceteris paribus, for appreciation of the country's currency.

This is because due to better quality of goods, the demand for this country goods will increase compare to the good of the rest of the world. Hence demand for this country currency will increase. Therefore the currency will appreciate compare to the rest of the world country currency.

Hence option B is the correct answer.