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Question
How does giving incentives for the exports influence foreign exchange rate? Explain
Solution
The incentive for exports will lead to an increase in exports, and hence, there is an increase in the supply of foreign exchange. Assuming other things remain constant, an increase in the supply of foreign exchange will reduce the foreign exchange rate. Hence, this is reflected by a shift in the supply curve as shown below
DD and SS are the initial demand and supply curves of foreign currency, respectively. As there is a decline in the demand for the foreign exchange rate, the new equilibrium is established at Point E′. Here, it states that the currency appreciates with a fall in the exchange rate from OR to OR1, and the demand and supply of foreign currency rises to OQ1
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