"economics"exercise:wealth effect

B is correct. Forward premium = Forward rate – Spot rate = 1.3001 – 1.2952 = 0.0049. To convert to points, scale four decimal places—that is, multiply by 10,000 = 10,000 × 0.0049 = 49 points. Because the forward rate exceeds the spot rate for the base currency (euro), the euro is trading at a forward premium of 49 points. 

C is incorrect. When the forward rate (1.3001) is higher than the spot rate (1.2952), the base currency (EUR) is said to be trading at a forward premium, not a discount, to the price currency (USD). 

A is incorrect. When the forward rate (1.3001) is higher than the spot rate (1.2952), the forward points are positive, and the forward rate is said to be trading at a premium to the spot rate. The wrong number is derived from 1.3001 – 1.2952 = 0.0049. The USD/ EUR is quoted to four decimal places, so it needs to be scaled up by four decimal places or multiplied by 10,000 to 49 points.

B is correct. At full employment, a weaker currency reduces the purchasing power of all domestic currency denominated assets (including the present value of current and future income). Households respond by reducing general expenditures and increasing savings. This response is the wealth effect and reflects the proportion of one’s income that is saved (or spent). 

A is incorrect. The income effect arises when the price of a good changes: with currency depreciation, foreign goods are more expensive, so real purchasing power (income) is reduced. 

C is incorrect. The substitution effect refers to the changes in the composition of spending across different product areas. With currency depreciation, less foreign goods relative to domestic goods are purchased.