Example: Exchange on Aggregate Demand

key terms

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exchange rate

net exports

An appreciation of the exchange rate:

Let’s say the exchange rate for the US dollar to the Mexican peso appreciation from e = 1 peso/$ to e = 2 peso/$. You’re in the business of selling good ol’ American pecan pies to Mexico. In order for the local Mexican store to buy your pecan pies, it must first buy dollars. If it has 10 pesos and you sell pecan pies for a dollar each, then under the original exchange rate the Mexican store exchanges its 10 pesos for 10 dollars and buys 10 pecan pies. After the appreciation, the Mexican store exchanges its 10 pesos and only gets 5 dollars. Therefore it is only able to buy 5 of your pecan pies.  This happens with anyone who sells to Mexico, so the demand from Mexico for American goods falls, reducing net exports and shifting the aggregate demand curve to the left.

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