Question

Q. With reference to the devaluation of a currency, consider the following statements:

Select the correct answer using the codes given below:

• A. 1 only
• B. 2 only
• C. 1 and 2 only
• D. 1, 2 and 3

Answer 1

The correct option is C 1 and 2 only

Explanation:

• Statement 1 is correct: The devaluation of a currency means the deliberate lowering down of the external value of a unit of home currency. Devaluation is the result of deliberate government decisions for the achievement of balance of payments equilibrium.
• Statement 2 is correct: As devaluation is undertaken, the home currency becomes cheaper relative to the foreign currency. The foreigners start thinking that the devaluing country has become a cheaper market. Therefore, they direct their demand to that market and the devaluing country finds opportunities to expand its exports. At the same time, the importers of the devaluing country start feeling that the foreign market has become relatively more costly. This leads to a reduction in the demand for foreign products. The consumers start switching their demand to home-produced goods.
• Statement 3 is incorrect: According to the Marshall Lerner condition, If the sum of elasticities of demand for exports and imports is greater than unity, devaluation will improve the balance of payments i.e reduce deficits.