If Malaysia wants to maintain a fixed exchange rate of 1.25 ringgit per euro, it should ___ (drop down options are BUY or SELL) euros in the foreign exchange market. To be successful, this policy would have to ____ (drop down options are DECREASE THE DEMAND FOR, DECREASE THE SUPPLY OF, INCREASE THE DEMAND OF, INCREASE THE SUPPLY OF) euros by ___ billion Euros at any given exchange rate.
If Malaysia wants to maintain a fixed exchange rate of 1.25 ringgit per euro, it should ___ (drop down options are BUY or SELL) euros in the foreign exchange market. To be successful, this policy would have to ____ (drop down options are DECREASE THE DEMAND FOR, DECREASE THE SUPPLY OF, INCREASE THE DEMAND OF, INCREASE THE SUPPLY OF) euros by ___ billion Euros at any given exchange rate.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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If Malaysia wants to maintain a fixed exchange rate of 1.25 ringgit per euro, it should ___ (drop down options are BUY or SELL) euros in the foreign exchange market. To be successful, this policy would have to ____ (drop down options are DECREASE THE
Transcribed Image Text:**Title: Understanding Exchange Rate Crises**
**Exchange Rate and Crises**
*The Malaysian Ringgit Example*
The graph displayed illustrates the market for euros in terms of the Malaysian ringgit. Initially, the market is in equilibrium at an exchange rate of 2.5 ringgit per euro, with a quantity of 60 euros. However, a crisis emerges due to a sudden demand for foreign currency, which is typically motivated by investors needing euros either to settle foreign-denominated debts or to purchase foreign assets. Consequently, the demand curve shifts to the right from D0 to D1.
**Graph Explanation:**
- **Axes:**
- The horizontal axis represents the "Quantity of Euros" in billions.
- The vertical axis depicts the "Exchange Rate" in terms of ringgit per euro.
- **Curves:**
- There are two demand curves depicted in the graph.
- **D0 (Initial Demand Curve):** Represents the initial equilibrium state.
- **D1 (Shifted Demand Curve):** Indicates the shifted demand curve due to increased demand for euros.
- The supply curve is marked in orange with positive slope, indicating a typical upward-sloping supply relationship.
- **Equilibrium:**
- Initial equilibrium (where D0 intersects the supply curve) occurs at 2.5 ringgit per euro and 60 billion euros.
- The shift to the new demand curve D1 suggests a new equilibrium at a higher exchange rate and an adjusted quantity.
---
This text and graph serve as an educational tool to understand the dynamics of exchange rate fluctuations during a financial crisis, specifically using the Malaysian ringgit scenario as a case study.
Transcribed Image Text:**Exchange Rate Dynamics and Market Equilibrium**
If Indonesia were to maintain a fixed exchange rate at 10,000 rupiahs per euro, a surplus or shortage might occur in the foreign exchange market. The supply and demand for euros are illustrated in the accompanying diagram.
In this type of situation, disequilibrium states may occur if imbalances exist between the world demand and supply at the desired exchange rate.
1. **What happens if running out of euro reserves to continually purchase euros?**
- The fixed exchange rate may not be sustainable.
2. **What could lead foreign funds to drain reserves?**
- Persistent trade imbalances or lack of investor confidence.
_True or False: In the event of a sustained disequilibrium state, foreign funds tend to either flock towards financial markets or exit them for other regions._
- \( \text{True} \square \)
- \( \text{False} \square \)
**Diagram Explanation:**
The diagram shows the demand and supply of euros. The vertical axis represents the exchange rate (rupiahs/euro), and the horizontal axis depicts the quantity of euros.
- A higher exchange rate indicates more rupiahs are needed per euro, whereas a lower rate means fewer rupiahs are needed.
- The equilibrium point is where supply meets demand, indicating market balance.
- Deviations from this point may signal a surplus or shortage, leading to market adjustments.
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