5. Exchange-rate overshooting Aa Aa The following graph shows the short-term sup

Question

5. Exchange-rate overshooting Aa Aa The following graph shows the short-term supply schedule (S0) and demand schedule (DO) for the Mexicanpeso. S1 denotes the long-term supply schedule of pesos. On the graph, use the grey star symbol to indicate the initial equilibrium exchange rate. Suppose that the demand for pesos increases to D1. Use the black cross symbol to indicate the short-term equilibrium exchange rate. Then use the red cross symbol to indicate the long-term equilibrium exchange rate. Tool Tip: Dashed drop lines will automatically extend to both axes. EXCHANGE RATE (Dollars per pesol 6.00 50 Short-Term Equil. 480 Initial Equil. S1 3.60 Long-Term Equil 240 1.20 D1 DO 0.00 30 60 90 120 0 QUANTITY (Pesos Help Clear All

Explanation / Answer

Ans. Initial equilibrium when the short term supply=short term supply=demand (D) where, equilibrium exchange rate is $2.40 per Peso and 30 quantity of peso is equilibrium quantity.

If the demand curve shifts rightward then the exchange overshoots in the short run, it will rise to $4.20 per Peso and quantity rises to 60 Peso. But in the long run, the exchange rate falls and will be $3 per Peso and quantity will be 90 Peso.

The series of event are as follows:

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