Chapter 18.2, Problem 3R

To determine

To discuss: The drop in demand causes depreciation of currency.

Explanation of Solution

Flexible exchange rate: Under this system, the exchange of currency is set by the demand and supply of goods that can be purchased by that currency. For example, the demand for currency A is more than its supply. This will lead to an increase in value of currency A. If the demand and supply leads to the value of currency falls then it is regarded as depreciation.

For example, the demand for currency A demanded by the exporters of Country B is less than the currency A supplied. This means the demand for currency A is less than the quantity supplied. This will make the Currency A cheaper in relation to currency of Country B.