Question

Exhibit 35-4 Refer to Exhibit 35-4. Under a fixed exchange rate system, at the exchange rate of E 3, the dollar is __________ and there is a __________.

Answer 1

Please find diagram for question attached

Question options:

a.

overvalued; surplus of dollars

b.

undervalued; shortage of pesos

c.

overvalued; shortage of dollars

d.

undervalued; surplus of pesos

Answer:

Overvalued and there is a shortage of dollars

Explanation:

An increase in dollar price to buy peso means that dollar here is overvalued as it is above the equilibrium price(E2),and therefore it would be expensive to buy goods that are sold for a certain amount of dollars or in dollar currency with the Mexican pesos. This is because the fixed exchange rate system tries to ensure smooth and inexpensive trade between countries as it has to do with currency trading barriers by pegging a currency to another(in this case dollars) but here the dollar price increase for peso makes it more expensive to buy dollar products with pesos. Also this is caused here by the shortage of dollars.