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.

A decrease in income of a country leads to?

Leftward shift in the demand curve of foreign exchange.

Rightward sift in the demand curve of the foreign exchange.

Depreciation of domestic currency.

Appreciation of foreign currency.

✅ Correct Option: 1

Option 1 -> When income decreases, people buy fewer imports, reducing demand for foreign exchange, causing a leftward shift.

Option 2 -> This would occur with an increase in income, leading to more imports and higher foreign exchange demand.

Option 3 -> Decreased foreign exchange demand typically leads to domestic currency appreciation, not depreciation.

Option 4 -> With lower demand for foreign currency, it tends to depreciate, not appreciate.

Hence, Option 1: Leftward shift in the demand curve of foreign exchange -> When a country's income falls, consumers and businesses have less purchasing power, leading to reduced demand for imported goods and services. Since foreign exchange is needed to pay for imports, the demand for foreign currency decreases. This reduction in demand is represented graphically as a leftward (inward) shift of the demand curve for foreign exchange. This shift indicates that at any given exchange rate, less foreign currency is demanded than before -> correct

Question 41

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

Question 42

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

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.............

A decrease in income of a country leads to?

Solution

More from this set:

Keyboard Shortcuts

CUET Economics Past Year Questions (Topic-Wise)