Question 1

"There exists a positive relation between foreign exchange rate and supply of foreign exchange." Do you agree with the given statement ? Justify your answer with valid arguments.

Accepted Answer

Yes, I agree with the given statement. There exists a positive relationship between the foreign exchange rate and the supply of foreign exchange. When the foreign exchange rate rises (e.g., $1 rises from ₹81 to ₹82), domestic goods become relatively cheaper for foreign buyers. This encourages foreigners to increase imports from the domestic country, thereby raising the supply of foreign exchange. Additionally, speculators sell foreign currency when its price rises to realize profits, further increasing the supply. The supply curve of foreign exchange slopes upwards due to this positive relationship between the exchange rate and the quantity of foreign exchange supplied.

Question 2

“Under the flexible exchange rate system, the Central Bank does not intervene in the foreign exchange market.” Justify the statement, giving valid arguments. Explain the impact of home currency depreciation on the exports of a nation.

Accepted Answer

Yes, under the flexible exchange rate system, the Central Bank does not intervene in the foreign exchange market. The exchange rate is determined solely by the market forces of demand and supply. This is known as a 'clean float' where the currency's value fluctuates freely based on market conditions.

Impact of home currency depreciation: When the domestic currency depreciates (e.g., ₹81/$1 rises to ₹82/$1), it leads to: (1) Increase in exports — domestic goods become cheaper for foreign buyers, (2) Decrease in imports — foreign goods become more expensive for domestic buyers, and (3) Increase in national income — due to rise in net exports (exports minus imports).

Question 3

Identify, which of the following is not a source of supply of foreign exchange for India. (Choose the correct alternative)

Accepted Answer

(D) Foreign Direct Investment (FDI) by a German automobile manufacturer

Question 4

Read the items given in Columns I and II carefully and choose the correct pair of statements from the given alternatives. Alternatives :

Accepted Answer

(D) iv - 4

Question 5

Identify, which of the following is not a source of demand for foreign exchange. (Choose the correct option)

Accepted Answer

(D) Loans from Rest of the World

Class 12 Macro Economics: Foreign Exchange

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