Question

Introduction to the foreign-currency exchange market

In an open economy, why is the demand curve in the foreign-currency exchange market downward sloping?

A) Net capital outflow equals net exports.

B) A depreciation in the domestic currency causes exports to fall and imports to rise and, therefore, net exports to fall.

C) When the value of the domestic currency depreciates, domestic goods become less expensive relative to foreign goods, making domestic goods more attractive to domestic and foreign consumers.

D) A depreciation of the dollar reduces the quantity of dollars demanded in the market for foreign-currency exchange.

Answer 1

Ans:

C) When the value of the domestic currency depreciates, domestic goods become less expensive relative to foreign goods, making domestic goods more attractive to domestic and foreign consumers.

The demand curve for foreign currency is downward sloping because a higher exchange rate makes domestic goods more expensive and viceversa.