Question

(a) Explain the impact of rise in exchange rate on national income.
(b) Explain the concept of 'deficit' in balance of payments.

Answer 1

(a) Rise in exchange rate means depreciation of domestic currency due to which (i) Domestic goods become cheaper. As a result, exports of the domestic country will increase. (ii) Imports become expensive and the demand for imports will fall. Since, net exports are included in national income national income will increase.

(b) Deficit in Balance of Payments implies a situation when during a year, autonomous receipts are less than autonomous payments. To fix this situation, the government could do the following:

1. Borrows from international funds, which results in inflow of foreign exchange

2. Alternatively, the country could engage in official reserve transactions, running down its reserves of foreign exchange, in the case of a deficit by selling foreign currency in the foreign exchange market.