Question

The demand for British pounds increases, resulting in a depreciating US $.

A) Illustrate this on a diagram. Assume the initial U.S dollar price of a pound is 1.5 and the new U.S dollar price of a pound is 2.0. ($2,000)

B) True or False: The Federal Reserve could buy British pounds in exchange for US $ to stop the depreciation. ($1,000)

Answer 1

a). As the demand for the british pounds increases, the demand curve will shift to the rightward causing the depreciation of the U.S currency. This is shown by the above graph, the movement from the E to E1 shows the rise in the exchange rate. So here at the new equilibrium more dollars would be required for buying the pounds.

b). TRUE- by buying the british pounds the central bank limiting the supply of british pounds and increasing the supply of home currency. So in a way the central bank can control the depreciation