Is there any problem with the answer. It says Q3-Q2. It should be Q3-Q1 right? as we are comparing equilibrium rate of $1.5 /pound to $2/pound 1. Also in general can anyone recommend any alternate text on exchange rate. The course note chapter 16, I'm simply not able to assimilate. Too confusing.
I think you are referring to X3.34, part (iii). If the exchange rate is fixed at $2=£1, you can see from the diagram that the demand for £ would be only Q2 but the supply of £ would be Q3, so there is excess supply of Q3-Q2. To keep the £ at $2=£1, the central bank must demand Q3-Q2 of £, ie buy the excess. (If the central bank does nothing, market forces would reduce the value of the £ to the equilibrium value of $1.50=£1.) All textbooks will have a section on the exchange rate. A floating exchange rate is determined by the demand for and the supply of the currency. If the demand increases (eg because of an increase in demand for exports) the currency will rise; if the supply increases (eg because of an increase in demand for imports) the currency will fall.
