Why does exchange rate overshooting typically happen?

Multiple choice question for Exchange-Rate Determination. Select an option, then review the explanation below.

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Because local prices take time to respond to changes in demandDue to increased defense expenditures during warsSince elasticities tend to be lower over the long term compared to the short termBecause elasticities are lower in the short term than they are in the long term

Explanation

Exchange rate overshooting occurs because the responsiveness (elasticities) of economic variables is generally smaller in the short run than in the long run, causing exchange rates to react more sharply initially before settling over time.

Practice related questions from the same subject.

1.If a Big Mac costs $3 in the United States and 2 pesos in Mexico, what is the implied purchasing power parity (PPP) exchange rate between the peso and the US dollar?
2.If Japan, with its high savings rate, invests capital overseas, how is the Japanese yen likely to be affected, and what impact would this have on Japan's trade balance?
3.If interest rates are the same on similar assets in the U.S. and abroad, and investors expect the U.S. dollar to weaken relative to foreign currencies in the future, where are investment funds most likely to move?
4.If a country's money demand equals its money supply and its balance of payments is initially balanced, which of the following changes would cause the balance of payments to shift into a surplus?
5.Which market expectation would lead to the U.S. dollar strengthening against the Japanese yen?

Why does exchange rate overshooting typically happen?

Explanation

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