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Question
When price of a foreign currency rises, its demand falls. Explain why.
Solution
When the price of foreign currency rises then it implies that foreign goods have become expensive for the domestic residents of the country. This results in a fall in the demand for foreign goods by the domestic residents. Consequently, the demand for foreign currency falls.
For example, suppose the rupee-dollar exchange rate (price of dollars in terms of rupees) rises from say, from $1= Rs 50 to $1= Rs52. This implies that in order to purchase one dollar worth of foreign goods, the domestic residents now have to pay Rs 52 instead of Rs 50. Thereby, the demand for foreign goods decreases. Consequently, the demand for dollars decreases.
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