The relationships between demand and supply of the Olympios Dollar and the exchange rate with the Terranian Credit are given by the following functions: E = 8.75 -0.03D$ E = 0.02S$3.50 where: E = Exchange rate: = price of Olympios dollar (Terranian credits / Olympios dollars) Ds index of demand for Olympios dollar S$ = index of supply of Olympios dollar. a) i) Determine the exchange rate that would prevail under a clean float. ii) Explain what this exchange rate would mean for the balance of payments of Olympios. [3 marks] b) The government of Olympios elects instead to fix the exchange rate with the Terranian credit at E=1.5 credits per dollar. i) Describe what actions the central bank will need to take in the short run to maintain this exchange rate, and the state of the balance of payments. ii) Explain what measures would be required if the government wishes to maintain this exchange rate in the long run.
