Open Economy Macroeconomics Class 12 Economics Exam Questions

Please refer to Open Economy Macroeconomics Class 12 Economics Exam Questions provided below. These questions and answers for Class 12 Economics have been designed based on the past trend of questions and important topics in your class 12 Economics books. You should go through all Class 12 Economics Important Questions provided by our teachers which will help you to get more marks in upcoming exams.

Class 12 Economics Exam Questions Open Economy Macroeconomics

Class 12 Economics students should read and understand the important questions and answers provided below for Open Economy Macroeconomics which will help them to understand all important and difficult topics.

Very Short Answer Questions

Question. Define flexible exchange rate.
Answer. Flexible rate of exchange is that rate which is determined by the demand and supply of different currencies in the foreign exchange market.

Question. What do you mean by disequilibrium in BOP?
Answer. Disequilibrium in BOP is means either there is a surplus or deficit in balance of payment account.

Question. Define foreign exchange rate.
Answer. Foreign exchange rate is the rate at which currency of one country can be exchanged for currency of another country.

Question. What do you mean by Foreign Exchange Market?
Answer. The foreign exchange market is the market where international currencies are traded for one another.

Question. What is meant by Fixed Exchange Rate?
Answer. Fixed Rate of exchange is a rate that is fixed and determined by the government of a country and only the government can change it.

Question. What is the balance of visible items in the balance of payments account called?
Answer. Balance of trade

Question. Which transactions bring balance in the BOP account?
Answer. Accommodating transactions bring balance in the BOP account.

Question. What is equilibrium rate of exchange?
Answer. Equilibrium exchange rate occurs when supply of and demand for foreign exchange are equal to each other.

Question. List two items of the capital account of BOP account.
Answer. i) external assistance ii) commercial borrowing iii) foreign investment

Question. Define forward market.
Answer. Market for foreign exchange for future delivery is known as the forward market.

Question. What is meant by balance of payments?
Answer. Balance of payments refers to the statement of accounts recording all economic transactions of a given country with the rest of the world.

Question. What is meant by appreciation of currencies?
Answer. Appreciation of a currency occurs when its exchange value in relation to currencies of other country increases.

Question. Define Spot exchange rate.
Answer. The spot exchange rate refers to the rate at which foreign currencies are available on the sport.

Question. What do you mean by balance of trade?
Answer. Balance of trade is the difference between the value of imports and exports of only physical goods.

Question. The balance of trade shows a deficit of Rs. 600 crores, the value of exports is Rs.1000 crores. What is value of Imports?
Answer. Balance of Trade = Exports of goods – import of goods
Import of good = Export of goods – (B.O.T)
= 1000- (-600)
= Rs. 1600.

Question. Define autonomous items in BOP.
Answer. Autonomous items in BOP refers to international economic transaction that take place due to some economic motive such as profit maximization. These items are independent of the state of the country balance of payments.

Question. What is the other name of autonomous items in the BOP?
Answer. The other name of autonomous items in BOP is above the line item.

Question. When does a situation of deficit in BOP arises?
Answer. A situation of deficit in BOP arise when autonomous receipts are less than autonomous payments.

Question. What is meant by managed floating?
Answer. It is a system that allows adjustments in exchange rate according to a set of rules and regulations which are officially declared in the foreign exchange market.

Question. What is meant by dirty floating?
Answer. Manipulate the exchange rate without following the guidelines issued by IMF is called dirty floating.

Question. Should a current account deficit be a cause for alarm? Explain.
Ans. Not really, since deficit in current account is carried over by the capital account.

Question. What is par value of exchange?
Ans. It is the equilibrium exchange rate in the foreign exchange market. At this exchange rate demand for foreign exchange equals to supply of foreign exchange.

Question. What does depreciation of Indian rupee imply for US dollar?
Ans. It means appreciation of the US dollars.

Question. Where are ‘borrowings from abroad’ recorded in the BOP account and why?
Ans. Borrowings from abroad are recorded in debit side of the capital account of BOP because it decreases long term home country assets owned by foreign private citizens and government.

Short Answer Type Questions

Question. Why is foreign exchange demanded?
Answer. Foreign exchange is demanded for the following purposes.
a) Payment of International loans
b) Gifts and grants to rest of the world
c) Investment in rest of the world.
d) Direct purchases abroad for goods and services as well as imports from rest of the world.

Question. Distinguish between fixed and flexible foreign exchange rate.
Answer. When foreign exchange rate is fixed by Central Bank/government, it is called fixed exchange rate. When foreign exchange rate is determined by market forces/mechanism, it is flexible exchange rate.

Question. When price of a foreign currency falls, the supply of that foreign currency also fall why?
Answer. When price of a foreign currency falls it makes exports, investment by foreign residents costlier as a result supply of foreign currency falls.

Question. Distinguish between autonomous and accommodating transaction of balance of payment account.
Answer. Autonomous transactions are done for some economic consideration such as profit,
such transactions are independent of the state of B.O.P. Accommodating transactions are
under taken to cover the deficit/surplus in balance of payments.

Question. What determines the flow of foreign exchange in to the country?
Answer. Following factors contribute to the flow of foreign exchange in to the country.
a) Purchases of domestic goods by the foreigners
b) Direct foreign investment and portfolio investment in the home country.
c) Speculative purchase of foreign exchange.
d) When foreign tourists come to India.

Question. Why does the demand for foreign exchange rise, when it price falls?
Answer. With a fall in price of foreign exchange , the exchange value of domestic currency increases and that of foreign currency falls. This implies that foreign goods become cheaper and their domestic demand increases. The rising domestic demand for foreign goods implies higher demand for foreign exchange. So there is inverse relationship between price and demand for foreign exchange.

Question. Are the concepts of demand for domestic goods and domestic demand for goods the same?
Answer. Demand for domestic goods and domestic demand for goods are two different concepts. Demand for domestic goods is demand for goods made by both domestic and foreign countries. Domestic demand for goods is demand for goods by our own country for goods which may be produced in foreign countries.

Question. What are official reserve transactions? Explain their importance in the balance of payments.
Answer. The country could engage in official reserve transactions. That is, running down its reserves of foreign exchange in case of a deficit by selling foreign currency in the foreign exchange market. The decrease (increase) in official reserves is called the overall balance of payments deficit (surplus). The basic premise is that the monetary authorities are the ultimate financiers of any deficit in the balance of payments (or the recipients of any surplus). A country is said to be in balance of payments equilibrium when the sum of its current account and its non-reserve capital account equals zero, so that the current account balance is financed entirely by international lending without reserve movements.

Question. Distinguish between the nominal exchange rate and the real exchange rate. If you were to decide whether to buy domestic goods or foreign goods, which rate would be more relevant? Explain.
Answer. Nominal exchange rate. It is defined as price of foreign currency in terms of domestic currency. Real exchange rate. It is defined as price of goods abroad relative to those at home. In order to buy domestic goods or foreign goods, real exchange rate is often taken as a more appropriate measure.

Question. Explain exchange rate function.
Answer. Flexible rate of exchange is that rate which is determined by the demand for and supply of the currencies concerned in the foreign exchange market. That is,
where,
R = f(D, S)
R = Exchange Rate
D = Demand for different currencies in the international market
S = Supply of different currencies in the international market.
The exchange rate at which demand for foreign currency is equal to its supply is called Par Rate of Exchange, Normal Rate or Equilibrium Rate. It is a flexible rate because it tends to change in accordance with changes in the supply of and demand for different currencies in the foreign exchange market.
Answer. 1. It ensures stability in exchange rate. The exporters and importers do not have to operate under uncertainty about the exchange rate. Thus, it promotes foreign trade.
2. It promotes capital movements. Fixed exchange rate system attracts foreign capital because a stable currency does not involve any uncertainties about exchange rate that may cause capital loss.
3. Stable exchange rate prevents capital outflow.
4. It prevents speculation in foreign exchange market.
5. It force the government to keep inflation in check. In case of fixed exchange rate system, inflation causes balance of payments deficit resulting in depletion of foreign exchange reserves.

Question. Let deficit in BOT be ₹ (-) 1,000 crores. The value of exports be ₹ 300 crores. Calculate the value of imports.
Answer. BOT = Value of Exports – Value of Imports
-1,000 = 300 – Value of lmports
-1,000 =-300 = – Value of lmports
-1,300 = – Value of lmports
Value of Imports = ₹ 1300 crores

Question. What are the effects of disequilibrium in BOP?
Answer. Some of the effects of unfavourable balance of payments are as follows:
1. It lowers economic credibility of a country.
2. It hampers economic development of a country.
3. It reduces foreign exchange reserves of a country.
4. It leads to exploitation of a country as foreign dependence sometimes assumes the form of political dependence.

Question. What are official reserve transactions? Explain their importance in the balance of payments.
Answer. The country could engage in official reserve transactions. That is, running down its reserves of foreign exchange in case of a deficit by selling foreign currency in the foreign exchange market. The decrease (increase) in official reserves is called the overall balance of payments deficit (surplus). The basic premise is that the monetary authorities are the ultimate financiers of any deficit in the balance of payments (or the recipients of any surplus). A country is said to be in balance of payments equilibrium when the sum of its current account and its non-reserve capital account equals zero, so that the current account balance is financed entirely by international lending without reserve movements.

Question. Distinguish between the nominal exchange rate and the real exchange rate. If you were to decide whether to buy domestic goods or foreign goods, which rate would be more relevant? Explain.
Answer. Nominal exchange rate. It is defined as price of foreign currency in terms of domestic currency.
Real exchange rate. It is defined as price of goods abroad relative to those at home. In order to buy domestic goods or foreign goods, real exchange rate is often taken as a more appropriate measure.

Question. How does fixed foreign exchange rate promotes capital movements and foreign trade.
Answer. (a) Fixed exchange rate ensures stability in the exchange rate. The exporters and importers do not have to operate under uncertainty about the exchange rate. Thus, it promotes foreign trade.
(b) It promotes capital movements. It attracts foreign capital because a stable currency does not involve in any uncertainties about exchange rate that may cause capital loss.

Long Answer Type Questions

Question. Give two examples explain why there is a rise in demand for a foreign currency when its price falls.
Answer. 

When price of foreign currency falls, imports are cheaper. So, more demand for foreign exchange by importers.
Tourism abroad is promoted as it becomes cheaper. So demand for foreign currency rises

Question. Differentiate between balance of trade and current account balance.
Ans. Balance of Trade. It is defined as the difference between exports and imports of goods. It takes into account only those transactions arising out of exports and imports of goods (the visible items). It does not consider the exchange of services between the countries. Symbolically, BOT = Vx – VM where Vx = value of exports, VM = value of imports. Balance on Current Accounts. The current account of BOP records imports and exports of visible items (goods) and invisible items (services) and unilateral transfers (gifts and donations). The net value of balances of visible and of invisible trade and of unilateral transfers is the balance on current accounts.

Question. Differentiate between devaluation and depreciation.
Ans. Devaluation
1. Devaluation means reduction in the external value of a country’s currency as a conscious policy measure adopted by the government of a country. In other words, we make our currency cheaper in terms of foreign currency. When a country suffers from continued deficit in its balance of payments, it may resort to devaluation of its currency with a view to encouraging exports and restricting imports.
2. It takes place in Fixed Exchange Rate System.
Depreciation
1. Depreciation of a currency means fall in value of domestic currency in terms of foreign currency, e.g., if value of rupee in terms of US dollar falls, say from f 50 to f 80 to a dollar, it will be case of depreciation of Indian rupee because more rupees are required now to buy one US dollar.
2. It occurs in Flexible Exchange Rate System.

Question. Differentiate between devaluation and depreciation.
Ans. Devaluation
1. Devaluation means reduction in the external value of a country’s currency as a conscious policy measure adopted by the government of a country. In other words, we make our currency cheaper in terms of foreign currency.
2. When a country suffers from continued deficit in its balance of payments, it may resort to devaluation of its currency with a view to encouraging exports and restricting imports.
3. It takes place in Fixed Exchange Rate System.
Depreciation
1. Changes in demand and supply of foreign exchange (say dollar) affects the equilibrium exchange rate.
2. If the demand for foreign exchange (say US dollars) increases, supply schedule remaining the same, the exchange rate will rise. A rise in exchange rate implies appreciation of the US dollars (or depreciation of the Indian rupees).
3. It takes place in flexible exchange rate system.

Question. Explain capital account of BOP?
Ans. Capital Account. It records capital transfer such as loans and investment between one country and the rest of the world which causes a change in the asset or liability status of the residents of a country or its government.
(a) Private Capital. In this only resident’s capital transactions are included. It can be longterm or short-term capital. Long-term capital inlcudes direct investment in shares, real estate, bonds, long-term loans, etc., whereas short-term capital inlcudes short-term loans and repayment with their original maturity of one year or less. Example. Investment by an individual of one country to another country.
(b) Banking Capital. It includes foreign financial assets and liabilities of the government and the central bank receipts of repurchases from IMF.
(c) Official Capital. It is divided into:
(i) Loan. It includes credit granted by foreign governments and international institutions to central and state governments.
(ii) Amortisations of capital It means purchase and resale of securities sold to the foreigners.
(iii) Miscellaneous errors and omissions. These indicate understatement or overstatement of receipts and payments. At times data may be incomplete or inaccurate (i.e. errors) or one side of transactions may escape recording (i.e. omissions).
(d) Gold and Foreign Capital. These are essential for stabilising the foreign exchange rate of the home currency. This reserve keeps changing depending on the net balance of other transactions.

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