Question

suppose that labor is mobile between countries a and b. if the relative demand for goods rises in country a, then labor can flow from ______. it may be possible in this situation for countries a and b to ____ which would help to ______.

country b to country a; fix the exchange rate between the two countries (or have a common currency); eliminate the risks associated with having a flexible exchange rate
country a to country b; fix the exchange rate between the two countries (or have a common currency); eliminate the risks associated with having a flexible exchange rate
country b to country a; impose trade restrictions upon one another; increase employment in country a
country a to country b; adopt flexible exchange rates; reduce the risk of exchange rate fluctuations

Explanation:

Analyze the economic shock and labor flow

Using the Optimum Currency Areas knowledge point

An increase in the relative demand for goods in country A creates an asymmetric shock: demand rises in country A and falls relatively in country B. This leads to upward pressure on wages and employment in country A, and downward pressure in country B. Since labor is mobile between the two countries, workers will migrate from country B to country A to seek better employment opportunities, helping to restore equilibrium.

Evaluate the exchange rate system and welfare implications

Using the Optimum Currency Areas knowledge point

High labor mobility acts as an adjustment mechanism that substitutes for nominal exchange rate flexibility. Consequently, it becomes feasible for countries A and B to fix the exchange rate between them (or adopt a common currency). This monetary integration eliminates the transaction costs and exchange rate risks associated with having a flexible exchange rate system.

Match with the correct option

Using the Optimum Currency Areas knowledge point

The correct sequence of completions is:

1. Labor flows from country B to country A.
2. This mobility makes it possible to fix the exchange rate between the two countries (or have a common currency).
3. This arrangement helps to eliminate the risks associated with having a flexible exchange rate.

This matches the first option.

Answer:

• (A) country B to country A; fix the exchange rate between the two countries (or have a common currency); eliminate the risks associated with having a flexible exchange rate (Correct answer)
• (B) country A to country B; fix the exchange rate between the two countries (or have a common currency); eliminate the risks associated with having a flexible exchange rate
• (C) country B to country A; impose trade restrictions upon one another; increase employment in country A
• (D) country A to country B; adopt flexible exchange rates; reduce the risk of exchange rate fluctuations