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Question

State any two factors that explain the contraction of supply of foreign currency when its price in terms of the domestic currency falls.


Solution

(i) When foreign currency becomes cheaper (in relation to domestic currency), purchasing power of the foreign currency in the domestic economy tends to reduce. This causes a reduction in exports from the domestic economy. Accordingly, supply of foreign currency reduces.

(ii) When foreign currency becomes cheaper (in relation to domestic currency) and its purchasing power reduces in the domestic market, foreigners are less inclined to make (Foreign Direct Investment). Accordingly, the supply of foreign currency reduces.

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