Macro

Balance of Payments

Medium

Comprehension:

Read the passage carefully and answer the questions based on the passage:

Income and the Exchange Rate

When income of a country increases, consumer spending increases. Spending on imported goods is also likely to increase. When imports increase, the demand curve for foreign exchange shifts to the right. There is a depreciation of the domestic currency. If there is an increase in income abroad as well, domestic exports will rise and the supply curve of foreign exchange shifts outward. On balance, the domestic currency may or may not depreciate. What happens will depend on whether exports are growing faster than imports. In general, other things remaining equal, a country whose aggregate demand grows faster than the rest of the world’s normally finds its currency depreciating because its imports grow faster than its exports. Its demand curve for foreign currency shifts faster than its supply curve.

Other things remaining same, if the income abroad increases, what is the likely effect of the same on national income of the domestic economy?

National income is likely to fall.

National income is likely to rise.

National income will remain unaffected.

National income will initially fall and then rise.

✅ Correct Option: 2

Option 1 -> If income abroad increases, it adds to net factor income from abroad, so national income would not fall.

Option 2 -> National income includes income earned by domestic residents both at home and abroad. An increase in income earned abroad increases net factor income from abroad (NFIA), thereby raising national income.

Option 3 -> Income earned abroad is a component of national income (GNI = GDP + NFIA), so it cannot remain unaffected.

Option 4 -> There is no economic reasoning for national income to first fall and then rise when income abroad simply increases.

Hence, Option 2: National income is likely to rise -> National Income (or GNI) is calculated as GDP plus Net Factor Income from Abroad (NFIA). NFIA represents the difference between income earned abroad by domestic residents and income earned domestically by foreign residents. When income earned abroad by domestic residents increases (other things remaining constant), NFIA increases, which directly increases the national income of the domestic economy. This is why countries with significant populations working abroad often see their national income boosted by remittances and foreign earnings. -> correct

Question 41

If the volume of imports of a country are growing faster than its volume of exports, its gross domestic product _______.

Question 43

A decrease in income of a country leads to?

Question 44

A country whose aggregate demand grows faster than the rest of the world's normally finds its currency______.

Question 45

If the income of the country and income abroad increase simultaneously, then the domestic currency will.............

Other things remaining same, if the income abroad increases, what is the likely effect of the same on national income of the domestic economy?

Solution

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