When the price level falls it causes the real exchange rate

When the price level falls, it causes the real exchange rate to depreciate. This is called the

When the price level falls, it causes the real exchange rate to depreciate. This is called the Select one: a. Wealth effect o b. Interest-rate effect o c Open economy effect d. None of the above

Solution

The price levels of different commodities have a direct impact on the exchange rate of the economy. This is known as the exchange rate effect. If the price level of a commodity falls, this increases the purchansing power of the foreign currency and thus, the value of the real exchange rate will be less and the real exchange rate will depreciate as a result. Similarly, if the price level of any commodity rises, the value of the real exchange rate will be more and it will appreciate. Thus, the exchange rate effect causes appreciation or depreciation in the rela exchange rate of an economy due to changes in the price levels of the commodities.

In the problem provided, option a says the wealth effect, which is hte change in the spending trends of the investors when the values of the stock prices fluctuate. If the stock prices rise, the investors tend to spend more and if they fall, the investors would like to save for the future and thus, spend less. Hnec, option a. is irrelevant.

Option b. says interest rate effect, which is the phenomenon of the increase in the prices of the investment causing the interets rate to rise. When interest rate rises, the investment will decrease because people will be less interested in investment due to a hike in the prices. Also, with higher interest rates, people will prefer not to block their money in investments for a long period of time.

Option c. says the open economy effect, which is also known as the international trade effect. This happens when the price of domestic goods rises in relation to the price of the foreign goods, there will be less exports. With less exports, the aggregate expenditure will also fall.

Thus, option d. none of the above is the answer.