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

Chapter 6 – Open Economy Macroeconomics

1.

Ans:

Points of difference	Balance of trade	Current account balance
Definition	It is the difference between a nation’s import and export values of goods.	It is the difference between a nation’s unilateral transfers, imports, and exports of commodities and services.
Components	1. Goods export 2. Goods imports.	unilateral transfers, export and import of goods, and export and import of services.
Nature of transactions	It exclusively keeps track of transactions involving tangible objects, or products.	It keeps track of transactions involving both visible (goods) and invisible (services) goods as well as unilateral transfers.

2.

Ans: Transactions conducted by a country’s monetary authority that result in alterations to official reserves are referred to as official reserve transactions (ORT). The transactions encompass the acquisition and disposition of currency in the exchange market for alternative assets and foreign currencies. Foreign currencies are sold in the exchange market during deficit periods and purchased during surplus periods. The fluctuations in official reserves are referred to as the balance of payments surplus and deficit, respectively.

The significance of official reserve transactions in the balance of payments includes the following aspects:

1. They assist in correcting deficits or surpluses in the balance of payments.
2. The purchase of one’s own currency is classified as a credit item in the balance of payments, while the sale is classified as a debit.

3.

Ans: The nominal exchange rate represents the value of a foreign currency in terms of the local currency. The nominal exchange rate represents the price of one unit of foreign currency, such as a dollar, expressed in terms of domestic currency, such as rupees. The exchange rate is defined as the amount of currency, specifically rupees, required to purchase one dollar. The nominal exchange rate is defined as the price at which one American dollar can be exchanged for 50 Indian rupees, or equivalently, the price at which one dollar can be acquired for Rs.50. The real exchange rate represents the price of imported goods in comparison to the price of domestic goods. Real exchange takes place when the expense of obtaining one unit of domestic currency, such as rupees, is articulated in terms of a foreign currency, such as dollars. In the aforementioned example, 1 rupee is equivalent to 2 cents, given that 1 dollar equals 100 cents. International visitors to the United States should recognize the higher costs of American goods relative to those in their home countries.

The real exchange rate
In this context, P represents the price level of the domestic currency, e denotes the nominal exchange rate, and the price level of the domestic currency is also indicated by P. For instance, if a watch is priced at a certain amount in the United States and the nominal exchange rate is 50, it should be valued at Rs 2,000 with a corresponding real exchange rate of.

4.

Ans:

5.

Ans: When other countries used the gold standard, their money was measured in gold instead of their own. So, the value of a currency was based on its gold content. When there was an open market, the value of gold set the exchange rate. Low and high limits were set, but it was free to change within those limits. The exchange rate stayed the same because of the gold standard. All countries keep a gold stock to use as money. The way things are changed when the gold standard is used is through the price-specie-flow system that David Hume suggested. If there is a mismatch in the balance of payments, a gold counter-flow will fix it. The set exchange rate was kept up by a method of automatic equilibration.

6.

Ans: In a flexible exchange rate system, the rate of exchange is set by the balance of supply and demand. The point at which supply and demand are in perfect harmony is known as the equilibrium rate of exchange. The figure below can help explain this:

The x-axis shows how much foreign currency is being bought and sold, and the y-axis shows the exchange rate. DD is the downward-sloping demand curve that shows how demand for foreign currency and the exchange rate are related in the opposite way. The supply curve, on the other hand, goes up, which means that the exchange rate and the amount of foreign currency available are positively related. If there is an equal amount of demand and supply of foreign exchange, the exchange rate is said to be in equilibrium (E). If the exchange rate goes up to OR1, the supply is more than the demand, hence the exchange rate has to go back down to OR. If the exchange rate goes down to OR2, on the other hand, there is too much demand and not enough supply. So, the exchange rate goes up from R2 to R. So, the equilibrium exchange rate (OR) is based on how much foreign currency is in demand and how much is available.

7.

Ans:

Devaluation	Depreciation
When the government formally lowers the currency exchange rate relative to the exchange rate of another nation, this is known as devaluation.	Instead of the government, the global market’s dynamics of supply and demand cause currency depreciation.
Lowering the fixed exchange rate on the global market results in devaluation.	On a floating exchange rate, depreciation takes place.
There is no set period of time for currency devaluation.	It happens daily in international marketplaces.

8.

Ans: A managed floating exchange rate system is one where market forces dictate the foreign exchange rate. The central bank or government can affect the exchange rate by participation in the foreign market. It assists in stabilizing exchange rates by enabling the purchase and sale of foreign currency. It facilitates exchange rate adjustments according to established rules and regulations that are publicly disclosed in the foreign market.

1. It is a hybrid of a fixed and a variable exchange rate system.
2. In this system, the central bank intervenes in the foreign exchange market to maintain exchange rate fluctuations within established limits. The objective is to maintain the exchange rate as close to zero as feasible.
3. The central bank sustains foreign exchange reserves to guarantee that the exchange rate stays within the targeted range.
4. It is referred to as ‘Dirty Floating.’

9.

Ans: There is a tight relationship between the terms “demand for domestic goods” and “domestic demand for goods” in an economy that is closed. A free market economy, on the other hand, gives these two concepts a completely distinct connotation. The term “demand for domestic goods” encompasses both domestic and international demand among consumers of domestic commodities. home demand for goods, on the other hand, refers to the desire that exists inside a country’s home market for products that are either produced domestically or in other countries (foreign countries).

10.

Ans: The marginal propensity to import is how much more a country imports as its income goes up. It is how much a country’s imports go up or down as its GDP changes.

This shows us that M = 60 + 0.06Y

Now, m = 0.06, which is the marginal tendency to import.

The marginal tendency to import has a negative effect on the aggregate demand function. So, when income goes up, aggregate demand goes down since more money is spent on buying goods from other countries.

11.

Ans: In case of a closed economy, equilibrium level of income is given by

By comparing the denominators of the two multipliers in equations (1) and (2), it is evident that the multiplier in an open economy is lesser than that in a closed economy. This is due to the fact that the denominator in an open economy is greater than the denominator in a closed economy.

12.

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13.

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14.

Ans: According to question

15.

Ans: At an economy’s equilibrium level, income and savings are equal, but in an open economy, investments and savings diverge.

Y, C, and G can be thought of as national savings (S) or net national income, which is the amount left over after all government expenditures and consumption.

16.

Ans: One of the most significant factors that determines the amount of trade that takes place in a country is the exchange rate. The answer to this question reveals that the inflation rate in country A is higher than that of country B. Due to the fact that the exchange rate is set in this scenario, it will be advantageous for nation A to import goods from country B, and it will also be advantageous for country B to sell goods to region A. Therefore, country A will be suffering a trade deficit because the amount of goods imported is greater than the amount of goods exported, and country B will be experiencing a trade surplus because the amount of goods exported is greater than the amount of goods imported.

17.

Ans: The current account deficit is the difference between the total amount of goods, services, and transfers that are imported and the total amount that are exported. This is because of high inflation, slow economic growth, and the fact that it is hard to export because the exchange rate is set. Because of this problem, a country owes money to the rest of the world. But this shouldn’t always be seen as a bad thing; countries may have current account deficits to improve productivity and exports in the future. Also, additional investment will help build up the capital stock, which will lead to more production in the future.

18.

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19.

Ans: The subsequent exchange rate mechanisms contributed to the stabilization of external accounts:

1. A crawling peg is a mechanism of ongoing and systematic changes permitting a fluctuation of 1% at any moment.
2. The arrangement of larger bands permits modifications in fixed exchange rates. A 10% variance is implemented between the currencies of any two nations. A nation may devalue its currency to enhance the balance of payments. This will result in heightened demand for domestic goods due to the increased purchase power of foreign currencies, leading to greater exports.
3. The third form is referred to as managed floating, wherein the government have the authority to adjust the exchange rate according to prevailing circumstances. The variation is unrestricted, in contrast to the preceding two measurements.

Related Study Resources of Chapter 6 – Open Economy Macroeconomics

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Sl No.	Related Links
1	Class 12 Economics Chapter 6 Open Economy Macroeconomics – Important Questions
2	Class 12 Economics Chapter 6 NCERT Textbook

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