Answer to Question #156579 in Macroeconomics for SITI FARHANA BT ABDUL HAKKIM

Question

Malaysia adopts a fixed exchange rate system in its trade with Pakistan. Assume that the Pakistani government decides to reduce import of palm oil from Malaysia. Explain and show the effect on equilibrium level of exchange rate between Malaysian Ringgit-Pakistan Rupee (MYR / RP), the values of the Malaysian Ringgit and Pakistan Rupee as well as the supply of Malaysian money.

Answer 1

If the Pakistani government decides to reduce the import of palm oil from Malaysia it would lead to less supply of Pakistani rupee in Malaysia and hence due to less supply the value of the Pakistani rupee would increase, the value of the Malaysian ringgit would fall in terms of Pakistani rupee and hence the equilibrium level would rise. Due to a fall in the value of the Malaysian ringgit and a rise in the value of the Pakistani rupee the supply of the Malaysian ringgit would fall.