Open Economy Macroeconomics

Question 1

What is Foreign Exchange?

Answer 1

It refer to all currencies other than the domestic currency of the given country.

Question 2

What is Foreign Exchange Rate?

Answer 2

It refers to the rate at which one currency is being exchanged for the other.

Question 3

Which are the forces that determine Exchange rate?

Answer 3

Demand and Supply.

Question 4

What is Currency Depreciation?

Answer 4

It refers to decrease in the value of domestic currency in terms of foreign currency. (It makes domestic currency less valuable and more of it is required to buy the foreign currency)

Question 5

Currency Depreciation ________ imports and _______ exports.

Answer 5

Discourage/Decrease

Encourage/Increase

Question 6

Currency Depreciation will ________National income.

Answer 6

Increase (since exports increase and imports decrease, NET EXPORTS= Exports-Imports will increase National Income).

Question 7

What is Currency Appreciation?

Answer 7

It means increase in the value of domestic currency in terms of foreign currency. (The domestic currency become more valuable and less of it is required to buy the foreign currency)

Question 8

Currency Appreciation ________ imports and _______ exports.

Answer 8

Encourage/Increase

Discourage/Decrease

Question 9

Currency Appreciation will ________National income.

Answer 9

Decrease (since exports decrease and imports increase, NET EXPORTS= Exports-Imports will decrease National Income).

Question 10

What are the 3 types of Foreign exchange rates?

Answer 10

1. Fixed Exchange rate/Pegged Exchange rate
2. Flexible Exchange rate/Floating Exchange rate
3. Managed Floating rate system/ Dirty Floating Exchange system (widely used)

Question 11

What is Fixed Exchange rate/Pegged Exchange rate?

Answer 11

Officially(By the government) fixed in terms of gold or other currency (external standard)

Question 12

How is Flexible Exchange rate/Floating Exchange rate determined?

Answer 12

By the forces of Demand and Supply.(no intervention of govt)

Question 13

What is Managed Floating rate system/ Dirty Floating Exchange system?

Answer 13

Hybrid of fixed and flexible exchange rate system.

Question 14

Merit of Fixed Exchange rate System?

Answer 14

Ensures stability in foreign trade and capital movement.

Question 15

Demerit of Fixed Exchange rate system?

Answer 15

Since there are so many foreign exchange it is not possible to fix and keep changing the exchange rate for everyone, it is difficult for govt.

Question 16

Demerit of Flexible Exchange rate?

Answer 16

Govt wont have any control over capital movement and foreign exchange.

Question 17

When demand for foreign exchange rises?

Answer 17

1. Import of goods and service
2. Tourism
3. Unilateral transfer sent abroad (ie payments to abroad as gifts etc)
4. Purchase of assets in foreign countries
5. Speculation (Act of making gains from appreciation of currency)

Question 18

When supply of Foreign exchange arises?

Answer 18

1. Export of goods and services
2. Foreign Investment
3. Remittances from abroad (ie unilateral payments from abroad)
4. Speculation

Question 19

In Managed floating system how is Foreign exchange rate determined?

Answer 19

Using market forces but at the same time Central Bank also influences the exchange rate.

Question 20

What is the aim of Managed floating system?

Answer 20

To keep the exchange rate close to target market.