Important Questions with Solutions of Class 12 Economics Chapter 6 – Open Economy Macroeconomics

1) Explain the reason for the increase in demand for foreign exchange once there is a decline in product prices.

Ans – Whenever there is a decline in the price of foreign exchange, the domestic currency’s exchange value will increase compared to the decreasing value of the foreign currency among total goods.

This shows that foreign products turn cheap when there is an increase in demand for domestic goods. This steady rise in local demand for foreign products gives us a sign of foreign currency increase. Ultimately, there will be a robust connection between foreign exchange demand and the cost of the product.

For instance, if the cost of 1 USD decreases from ₹75 to ₹70, the domestic demand for US imports is at a higher rate with an increase in US goods demand locally making the products in the US cheaper to make a purchase. So, there will be an increase in demand for US dollars as it will be on the rise.

2) Explain the distinctive features of fixed exchange rates and flexible exchange rates!

Ans – The detailed difference between fixed exchange rates and flexible exchange rates can be classified as,

Aspect	Fixed Exchange Rate	Flexible Exchange Rate
Definition	The final rate is decided and controlled by the central government	The rate is determined by supply forces due to flexible exchange rate features
Overall Control	Governed by the apex bank or monetary authority	They are managed by supply and demand dynamics.
Currency Effect	Involves conscious devaluation or revaluation of a currency	Natural appreciation or depreciation of a currency value
Hedging	No need for hedging against currency fluctuations	Uses hedging to mitigate currency risk factors

3) Differentiate the factors of autonomous and accommodating transactions based on the balance of account payments.

Ans – The major difference between autonomous and accommodating transactions based on the balance of account payments can be classified as,

Aspect	Autonomous Transactions	Accommodating Transactions
Definition	These are economic transactions for profit or other inherent economic motives such as the profit maximization process	Transactions intended to balance out the concurrent deficits or surplus items in the autonomous transactions are defined as accommodating transactions
Impact on BOP	Not affected  by the stance of BOP	Might happen in BOP to maintain a proper balance
Current or Capital Account	Appears in the current account and capital account	The accommodating transaction can happen in capital accounts
Substitute Identity	It can be also defined as “above-the-line items”	It is been termed as “below-the-line items”

4) Define foreign exchange and foreign exchange rate, and describe the relationship between foreign exchange rate and demand for foreign exchange.

Ans – The foreign currency about the domestic currency, which is an utmost requirement of international trade and transactions. Any currency other than the Indian rupee qualifies as foreign exchange in India.

The foreign exchange rate means a level of valuation given how much to quote or assign the domestic units that equivalently acquire each one particular unit for quotation using and comparing through use or an accounting application while externally measured as a domestic unit that will just compensate foreigner to attain home market rate for exchange end. Ultimately, the foreign exchange rate depicts the outer purchasing power using money

There are two primary ways of determining foreign exchange rates:

The traditional gold standard is a concept that depends on the conventional gold process replacing an outdated setup where a classical paper currency is incorporated for goods exchange. Since most major currencies are no longer tied, the gold standard concept doesn’t apply during this process.

One such paper currency standard is when the exchange rates between currencies are determined by their demand and supply in the foreign exchange market.

In practice, demand for foreign exchange arises when domestic residents or companies need to pay foreign entities, such as purchasing foreign goods, making gifts, or investing abroad. A higher level of imports increases this demand.

Here is the detailed bond between the foreign exchange rate and demand for foreign exchange from the below diagram:

The foreign exchange rate is inversely related to the demand for foreign currency. Demand is also upward sloping when expressed in graphical terms: demand increases with the exchange rate, while on the contrary, with an increasing slope downwards.

If the exchange rate rises, it increases the domestic consumer’s cost of paying for every unit of foreign currency imported by increasing the import cost and reducing the import demand. Consequently, it diminishes the demand for foreign currency. The foreign currency has higher demand and if the exchange rate goes down imports will now be cheaper.

For example, assume the exchange rate depreciates from R1 to R2. Now the demand for foreign currency increases from Q1 to Q2. This shows an inverse relationship between the depreciation of an exchange rate and the foreign exchange demand.

NCERT Questions for Class 12 Economics Chapter 6 – Open Economy Macroeconomics

Understanding open economy macroeconomics is crucial for students studying at the class 12 level. This branch of economics deals with how countries interact through trade, capital flows, and exchange rates. To help students prepare for their exams, here are some important questions related to open economy macroeconomics: