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Question
Recently Government of India has doubled the import duty on gold. What impact is it likely to have on foreign exchange rate and how?
Solution
An increase in import duty will lead to a fall in the import of gold. This will control the demand and hence there is decline in the demand for foreign exchange. Assuming other things remain constant, a decline in the demand for foreign exchange will reduce the foreign exchange rate. Hence, this is reflected by a shift in the demand curve to the left 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 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
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