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Chapter 21: Q3. (page 451)

The exchange rate between the U.S. dollar and the British pound starts at \(1 = 拢0.5. It then changes to \)1 = 拢0.75. Given this change, we would say that the U.S. dollar has ______ while the British pound has _______.

a. depreciated; appreciated

b. depreciated; depreciated

c. appreciated; depreciated

d. appreciated; appreciated

Short Answer

Expert verified

The correct option is option (c): appreciated; depreciated

Step by step solution

01

Depreciation and appreciation of currencies

An exchange rate determined by market forces can, and often does, constantly change, just as stock and bond prices do.

When a currency appreciates, fewer units are needed to buy a single unit of other currency. In contrast, in the case of depreciation purchasing power of the currency falls.

Thus, the depreciation of one currency implies an appreciation of other currency and vice-versa.

02

Relationship between US dollar and British pound

The initial exchange rate between the US dollar and the British pound is $1= 0.5 pounds. The change in the exchange rate is $1 = 0.75 pounds.

The purchasing power of the US dollar has increased by 0.25, as is evident from the given exchange rates.

Thus, given the changes, one can say that the US dollar has appreciated while the British pound has depreciated.

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Refer to the following table, in which Qd is the quantity of loonies demanded, P is the dollar price of loonies, Qs is the quantity of loonies supplied in year 1, and Qs鈥� is the quantity of loonies supplied in year 2. All quantities are in billions, and the dollar-loonie exchange rate is fully flexible.

QdPQsQ's
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a. What is the equilibrium dollar price of loonies in year 1?

b. What is the equilibrium dollar price of loonies in year 2?

c. Did the loonie appreciate, or did it depreciate relative to the dollar between years 1 and 2?

d. Did the dollar appreciate or did it depreciate relative to the loonie between years 1 and 2?

e. Which one of the following could have caused the change in relative values of the dollar (used in the United States) and the loonie (used in Canada) between years 1 and 2: (1) More rapid inflation in the United States than in Canada, (2) an increase in the real interest rate in the United States but not in Canada, or (3) faster income growth in the United States than in Canada?
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