Advertisements
Advertisements
Question
How is the rate of exchange determined in a flexible exchange rate system?
Solution
Under Flexible exchange rate system, the rate of exchange is determined by the market forces of demand and supply.
The demand curve of foreign exchange is downward sloping while the supply curve is upward sloping.
1. Downward Sloping Demand Curve - There is an inverse relationship between foreign exchange rate and quantity of foreign exchange demanded. Due to inverse relationship, the demand curve is downward sloping.
2. Upward Sloping Supply Curve - Supply curve is upward sloping due to direct relationship between foreign exchange rate and quantity of foreign exchange supplied.
Determination of Foreign Exchange Rate:
Under, flexible exchange rate system, the foreign exchange rate is determined by the market forces of demand and supply.
In the figure, the X-axis represents the quantity of foreign exchange demanded and supplied and Y-axis represents price per unit of foreign currency.
The exchange rate is determined at the intersection of the demand and supply curve i.e. at point E. In the diagram, OP1 is the exchange rate and OQ1 is the quantity of foreign exchange demanded and supplied. Any rate above or below this rate is a temporary fluctuation and equilibrium rate is established at the point of intersection of the two curves.
APPEARS IN
RELATED QUESTIONS
Foreign exchange transactions dependent on other foreign exchange transactions are called ______.
(a) In which sub-account and on which side of balance of payments account will foreign investments in India be recorded? Given reasons.
(b)What will be the effect of foreign investments in India on exchange rate? Explain.
Recently Government of India has doubled the import duty on gold. What impact is it likely to have on foreign exchange rate and how?
Why does the demand for foreign currency fall and supply rise when its price rises? Explain.
Other things remaining the same, when in a country the market price of the foreign currency falls, national income is likely (Choose the correct alternative)
a. to rise
b. to fall
c. to rise or to fall
d. to remain unaffected
Other things remaining the same, when the foreign currency becomes cheaper, the effect on national income is likely to be : (Choose the correct alternative)
a. Positive
b. Negative
c. Positive and negative both
d. No effect
How does giving incentives for the exports influence foreign exchange rate? Explain
Define foreign exchange rate.
The foreign exchange rate in India is on the rise recently. What impact is it likely to have on exports and how?
When price of a foreign currency rises, its supply also rises. Explain why.
How is the exchange rate determined under a flexible exchange rate regime?
______ rate is the price of one currency in terms of another.
Suppose it takes 1.25 yen to buy a rupee, and the price level in Japan is 3 and the price level in India is 1.2 Calculate the real exchange rate between India and Japan (the price of Japanese goods in terms of Indian goods).
Identify which of the following statement is true?
Why is the demand curve for foreign exchange negatively sloped?
Suppose the exchange rate was \[\ce{$}\]1 = ₹ 80 and later changed to \[\ce{$}\]1 = ₹ 92. What will be its effect on the following?
Import of gold jewellery by the USA from India
Briefly discuss the fixed exchange rate system of determining foreign exchange rate.
