Draw a foreign exchange market diagram to show equilibrium with a flexible or floating exchange rate. Suppose the initial exports X is $110, the supply curve is given by er = 0.01X, and the demand curve is given by er = 2.2 - 0.01X.

a)Plot the supply and demand curves of the foreign exchange market. Plot the new supply curve if the supply of US dollars declines at all levels of exports by $20.

Demand Curve

b)How does the decline in exports affect the foreign exchange rate?

The decline in exports

(Select One) (+/-)

the balance on current account balance and

(Select One) (+/-)

the supply of foreign

exchange derived from export receipts. The exchange rate rises by

0

to maintain equilibrium in the balance

of payments. The supply curve shifts to the

(Select One) (left/right)

.

c)How do exports and imports change to give balance of payments equilibrium at the new equilibrium exchange rate?

The decline in exports would

(Select One) (decific/surplus)

on the current account. The profitability and competitiveness of

exports is

(Select One) (+/-)

. The supply of foreign exchange from exports is

(Select One) (-/+)

to establish equilibrium.

d)What are the effects on the holdings of official reserves?

With flexible rates the foreign exchange market adjusts

(Select One) (with/without bank)

and there is

(Select One) (increase, decrease, no change)

in official reserves.