The diagram below shows the demand for foreign currency and the supply of foreign currency. The equilibrium exchange rate is e^*. Assume that Canada has a purely flexible exchange rate.

a. Show in the diagram the effect of a general inflation in Canada (when there is no inflation in the rest of the world). Explain.

b. Show what happens to the exchange rate if there is a large increase in foreign demand for Canadian telecommunications equipment. Explain.

c. Show the effect of an increase in Canadian investors’ demand for Japanese government bonds. Explain.

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Exchange Rate Units of Foreign Currency D S