Explanation:
C is TRUE: Both I and II.
Statement I: The increase in exports requires Italian exporters to exchange the dollars (USD) received for their domestic currency (EUR), which increases demand for EUR and strengthens the EUR relative to the USD. This strengthening of the EUR is reflected by an increase in the EUR/USD exchange rate because the EUR is the base currency in this natural quote convention.
Statement II: The subsequent, equilibrating force is a function of demand elasticity: the exported Italian goods (aka, the imported US goods) become more expensive to the customers in the U.S. These higher prices will lower the quantity demanded. Where the goods have high elasticity of demand (i.e., greater than one), the quantity changes faster than price.
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Italy exports over $50.0 billion in products to the United States (U.S.), including machinery/equipment, pharmaceuticals, vehicles, beverages, and commodities. According to the balance of payments (and trade flows), if Italy increases its exports to the U.S., which of the following is most likely:
I. Increase in the EURUSD exchange rate
II. As an equilibrating force, there will lower quantity demanded in the US for the imported Italian good
A
a) Only I
B
b) Only II
C
c) Both I and II
D
d) Neither
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