Assume that Canada and Kenya are trading partners. Assume that Canada experience significant inflation compared to...
Assume that Canada and Kenya are trading partners. Assume that Canada experience significant inflation compared to Kenya. Draw the foreign exchange market for the Canadian currency and show what happens to the demand for Canadian dollars. Be sure to identify if the canadian dollar will appreciate or depreciate?
Homework Answers
An increase in inflation rate in Canada as compared to Kenya will lead to decrease in the level of net exports of Canada and as the net exports decline, the demand for Canadian dollar will also decrease. The decrease in the demand will shift the demand curve leftwards to D'D' and thus new equilibrium occurs at point E2 where exchange rate has fallen and Canadian dollar has depreciated with respect Kenyan currency. This can be depicted in the diagram as:
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