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Question
When price of a foreign currency rises, its supply also rises. Explain why.
Solution
When the price of foreign currency rises, this implies that the domestic goods have become cheaper for the foreign residents. This is because they can now buy more goods and services with same worth of foreign currency. As a result, the foreign demand for domestic products rises. This leads to an increase in the exports of domestic country. As a result, the domestic country receives more foreign currency and its supply rises.
For example, suppose the rupee-dollar exchange rate (price of dollars in terms of rupees) rises from say, from $1= Rs 50 to $1= Rs 52. This implies that the foreign residents can now buy Rs 52 worth of goods with the same one dollar. Thus, the demand for domestic goods increases. As a result, the supply of dollars increases.
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