Final answer:
Rising U.S. income levels compared to Canadian income levels can lead to an appreciation of the Canadian dollar relative to the U.S. dollar due to increased U.S. demand for Canadian goods and a corresponding increase in demand for the Canadian currency.
Step-by-step explanation:
If the U.S. income level rises substantially more than the Canadian income level, then the equilibrium value of the Canadian dollar should be affected in terms of its exchange rate with the U.S. dollar. A higher income level in the U.S. implies increased purchasing power for U.S. residents, potentially leading to a greater demand for goods, including foreign goods.
As a result, U.S. consumers may convert more U.S. dollars into Canadian dollars to buy Canadian products, increasing the demand for the Canadian dollar. Assuming other factors remain constant, this increased demand for Canadian currency coupled with a stable or decreasing supply of Canadian dollars would cause the value of the Canadian dollar to appreciate or strengthen relative to the U.S. dollar.
Exchange rates operate on the principle that the appreciation of one currency relative to another leads to the depreciation of the second currency, and vice versa. For example, if a U.S. dollar is worth $1.60 in Canadian currency, a change in demand or supply could alter this ratio, impacting how much a car that sells for $20,000 in the United States would sell for in Canadian dollars.
In this scenario, an appreciation of the Canadian dollar may alter this dynamic, potentially reducing the incentive for cross-border shopping.