Final answer:
Gresham's law is an economic principle stating that 'bad money drives out good,' meaning that when two forms of money are in circulation, the one perceived as having lesser value will be used while the more valued money is hoarded. Ultimately this means undebased money is driven from circulation. An understanding of Gresham's law is crucial for sound economic policy and maintaining the integrity of the monetary system.
Step-by-step explanation:
Gresham's law is an economic principle stating that "bad money drives out good." In other words, when there are two forms of commodity money in circulation, which are accepted by law as having similar face value, the more valuable coins (good money) will be hoarded and the less valuable ones (bad money) will be used in circulation. This would generally answer option C) Undebased money will be driven from circulation. This is due to the tendency of people to hold onto commodities of higher value while using those of lesser value as currency.
However, when looking at modern currencies, the principle can also be relevant when currencies fluctuate in value due to economic policies, inflation rates, or changes in interest rates. For example, if one currency is expected to depreciate versus another, there is likely to be an increase in the supply of the weakening currency and a decrease in demand for it, as individuals divest themselves of the currency. This results in a devaluation of the currency as seen with the British pound in the given example.
Understanding Gresham's law is important as it can influence economic decisions and policies. For instance, if policymakers understand that low-quality money can drive high-quality money out of circulation, they might design systems to prevent the circulation of debased currency, thereby upholding the integrity of the monetary system.