Question

There is a flexible exchange rate system and only two countries in the world, the United States and Mexico. If the inflation rate in the United States rises relative to the inflation rate in Mexico, it follows that
a. the dollar will depreciate and the peso will appreciate.b. the peso will depreciate and the dollar will appreciate.c. both the peso and the dollar are likely to appreciate.d. both the peso and the dollar are likely to depreciate.

Answer 1

Answer: The correct answer is "a. the dollar will depreciate and the peso will appreciate.".

Explanation:  If the inflation rate in the United States rises relative to the inflation rate in Mexico, it follows that the dollar will depreciate and the peso will appreciate.

As inflation in the United States is higher, the dollar is affected by a loss of purchasing power, therefore it depreciates with respect to the Mexican peso.