indirect exchange rate effect on aggregate demand

CFA Level I Economics
#1

Hi Guys,

My first post :smiley: , whatever is underlined is my comment, whatever is not is directly from the mock

See the question below , the explanation regarding exchange rate did not make sense to me because an increase in exports does not mean an increase in aggregate demand, quite the opposite its the increase in imports that should mean more demand, any thoughts ?. (This is from Wiley mock)

Which of the following most likely represents the causes of an increase in aggregate demand?

Taxes Bank Reserves Indirect Exchange Rate

A. Decrease Increase Decrease

B. Decrease Decrease Increase

C. Increase Increase Decrease

Answer: A

Explanation given by book

• A decrease in taxes increases disposable income and consumption.

• An increase in bank reserves increases money supply, reduces interest rates, and

increases consumption and investment.

• A decrease (depreciation) in the indirect exchange rate (FC/DC) results in higher exports

and lower imports.

#2

The explanation by the book is right. The aggregate demand is increased as a result of increase in export. Export is considered as demand from outside of your country.

What makes confusion for you is that you think the aggregate demand is the one in your country. No, aggregate demand is demand of your goods and services from anywhere in the world. Thus increase in export increases the aggregate demand.

In this question, depreciation in indirect exchange rate makes the goods and services of your country price-attractive in other countries, hence foreigners start to buy your products more which is known as increase in export.

Hope, my comment is helpful to you.