Question

suppose there is a decrease in u.s. income and mexican income does not change. we would expect to see
both the dollar and the peso appreciate.
both the dollar and the peso depreciate.
the dollar depreciate and the peso appreciate.
the dollar appreciate and the peso depreciate.

Explanation:

Analyze the impact of U.S. income on imports

A decrease in U.S. income reduces the purchasing power of U.S. consumers. Consequently, U.S. demand for foreign goods and services, including those from Mexico, decreases. This leads to a reduction in the U.S. demand for Mexican pesos (\(\text{MXN}\)) in the foreign exchange market to pay for those imports.

Analyze the impact on the Mexican peso

Using the Exchange Rate Determination concept, when the U.S. demand for pesos decreases, the demand curve for the peso shifts to the left. With less demand for the peso, its value relative to the U.S. dollar decreases. Therefore, we expect the Mexican peso to depreciate.

Analyze the impact on the U.S. dollar

Since the exchange rate is relative, when the peso depreciates against the dollar, the dollar must conversely appreciate against the peso. Alternatively, because U.S. imports decrease, fewer dollars are supplied to the foreign exchange market to buy foreign currencies, shifting the supply of dollars to the left and causing the dollar to appreciate.

Match with the given options

Combining these effects, we expect the U.S. dollar to appreciate and the Mexican peso to depreciate. This directly matches the fourth option.

Answer:

• both the dollar and the peso appreciate.
• both the dollar and the peso depreciate.
• the dollar depreciate and the peso appreciate.
• the dollar appreciate and the peso depreciate. (Correct answer)