Final answer:
Exchange rates impact international trade flows by affecting import and export prices, leading governments to sometimes fix these rates. However, market dynamics such as inflation and capital flows make equilibrium in exchange rate markets difficult to maintain.
Step-by-step explanation:
Exchange rates are a critical component of international finance and trade. Variations in exchange rates can significantly affect international trade flows as they alter the cost of imports and exports. While a government may attempt to fix exchange rates to minimize disruptions of trade flows, especially when trade constitutes a substantial portion of the nation's economic activity, these rates are often subject to fluctuation due to numerous economic factors.
Movements in floating exchange rates reflect changes in market dynamics, including the effects of inflation, capital flows, and productivity growth within an economy. While governments may prefer stable exchange rates, the reality of market economies is that prices for goods and services constantly adjust in response to shifting supply and demand—a principle that extends to currency values as well. Therefore, achieving absolute equilibrium in exchange rate markets is challenging, as these rates ideally shift to mirror underlying economic conditions.