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

National Council of Educational Research and Training (NCERT) Book Solutions for class 12th
Subject: Economics
Chapter: Chapter 6 – Open Economy Macroeconomics

These Class 12th NCERT Solutions for Economics provide detailed, step-by-step solutions to all questions in an Economics NCERT textbook.

Click Here for Class 12 Economics Notes.

Class 12th Economics Chapter 6 – Open Economy Macroeconomics NCERT Solution is given below.

Question 1. Differentiate between balance of trade and current account balance,

Answer Different between balance of trade and current account balance

S. No Balance of Trade Current Account Balance
1 It is a difference between exports and imports of goods. It is net value of balances of visible and of invisible trade of unilalerel transfer
2 Balance of Trade Includes only visible Items Current account records both visible and invisible Items
3 It is a narrow concepts means it is only a part of current account balance. II is a wider concept and It Includes balance of trades.

Question 2. What are official reserve transactions? Explain their importance in the balance of payments.

Answer Official reserve refers to that the monetary authority (central bank) is financed the any deficit in the balance of payment. Official reserve
transactions take place when a country with draws from its stock of foreign exchange reserves to finance deficit in its overall balance of payment. A country wilh surplus in its overall BOP leads to rise in foreign exchanges reserves.

Importance Official reserve transactions help to bring a balance In the country’s overall balance of payment. So, it plays an important role in
economy of any country.

Question 3. 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 means the price of foreign currency in terms of domestic currency. Means, the number of units of domestic currency one must give up to get an unit of foreign currency.

Real Exchange Rate It refers to the relative price of foreign goods interns of domestic goods.

To buy domestic goods of foreign goods, at a point of time nominal exchange rate is more relevant.

Question 4. Suppose it takes 1.25 yen to buy a rupee, and the price level in Japan is 3 and the price level in India is 1.2 calculate the real exchanges rate between India and Japan.

Question 5. Explain the automatic mechanism by which BOP equilibriumwas achieved under the gold standard.

Answer The country from which we were importing and marking payment in gold would face an increase in prices and cost. There would be dis equilibrium. Normally the BOPof the country losing gold, and worsen that of the country with the favourable trade balance, until equilibrium In international trade is re-established at relative prices that keep Import and export In balance with no further net gold flow. Thus, fixed exchange rates were maintained by an automatic equilibrating mechanism.

Question 6. How is the exchange rate determined under the flexible exchange rate regime?

Answer Flexible exchange rate is determined by the forces of supply and demand in the international market. And the equilibrium exchange rate is determined at a level where demand for foreign exchange is equal to the supply of foreign exchange.

Sources of demand for foreign exchange

  • (i) Payment of international loans
  • (ii) Gifts and grants to rest of the world

Source of supply of foreign exchange

  • (i) Export to the rest of the world
  • (ii) Direct foreign investment
  • (iii) Direct purchase of goods and services by the non-residents in the domestic market.

In the figure, the equilibrium exchange rate i.e., E

Question 7. Differentiate between devaluation and depreciation

Answer Different between devaluation and depreciation

S.No Devaluation Depreciation
1 It means the decrease in the price of domestic currency under fixed exchange rates. It means decrease in the price of the domestic currency Interms of the floating exchange rates.
2 It takes place due to official action (by government) It takes place due to market forces
3 It takes place under fIxed (pegged) exchange rate system. It takes place under flexible exchange rate system.

Question 8. Would the central bank need to intervene in a managed floating system? Explain

Answer Managed floating is a system that allows adjustment in exchange rate according to set of rules and regulations which are officially declared in the foreign market. Under this system, also called dirty floating, central banks intervene to buy and sell foreign currency in an attempt to moderate exchange rate movements whenever they feel that such action are appropriate. Official reserve transaction are, therefore, not equal to zero.

Question 9. Are the concepts of demand for domestic goods and domestic demand for goods the same?

Answer No, both concept are not same demand for domestic goods refers the demand for goods made by both domestic and foreign countries. Domestic demand for goods refers the demand for goods by our own country for goods which may be produced in foreign countries

Question 10. What is the marginal propensity to import when M = 60 + 0.6Y? What is the relationship between the marginal propensity to import and the aggregate demand function?

Answer Marginal propensity to import indicates the extent to which imports are induced by changes in income of production.

It is given
M= 60 + 0.06Y
M=M+MY

Here (m) Marginal propensity to import = 0.06
The marginal propensity to import negatively affects the aggregate demand function.

When income increase aggregate demand decreases. This is because the additional income is spent on foreign goods and not on domestic goods.

Question 11. Why is the open economy autonomous expenditure multiplier smaller than the closed economy one?

Answer The open economy multiplier is smaller than in a closed economy because a part of domestic demand falls on foreign goods. An increase in
autonomous demand leads to a smaller increase in output compared to a closed economy

Question 12. Calculate the open economy multiplier with proportional taxes, T = tY, instead of lump-sum taxes as assumed in the text

Question 13. Suppose C = 40 + 0.8 YΔ, T = 50, I = 60, G = 40, X = 90, M= 50+ 0.05Y

(i) Find equilibrium income.
(ii) Find the net export balance at equilibrium income.
(iii) What happens to equilibrium income and the net export balance when the government purchases increase fron 40 to 50?

Question 14. In the above example, if exports change to X = 100, find the change in equilibrium income and the net export balance

Answer Given, C = 40 + 0.8 YΔ,
T=50
1=60
G=40
X =100
M =50+ 0.05Y

Net export balance
Nx = X – M- 0.05 Y
=100 – 50 – 0.05 x 600
= 50-30=20

Question 15. Explain why G – T = (s9 – I) – (X – M)

Answer In a closed economy, savings and investment are at equilibrium level of income. However, In an open economy savings and investments differ.

Question 16. If inflation is higher in country A than in country 8, and the exchange rate between the two countries is fixed. What is likely to happen to the trade balance between the two countries?

Answer The exchange rate is one of the most important determinant of a country. It plays a vital role in the country’s level of trade As per the above condition it is favourable for country A to import goods and on the other hand for country B export is favourable.

There would be no balance in trade between the two countries as country A is importing more goods as compared to exports which results in trade
deficit and on the other hand country B suffers from trade surplus because they are focusing more on exports than imports.

Question 17. Should a current account deficit be a cause for alarm? Explain.

Answer A current account deficit means that the value of imports for goods and services are greater than the value of exports it leads to several
causes which are
(i) Due to fixed exchange rate exports will become uncompetitive.
(ii) Economic growth is not favourable.
(iii) Inflation and borrowings become the major problems.

Thus, we can say that current account deficit be a cause for alarm because the that value of exports increased at a slow rate than the imports and there is an increase in the deficit or we can say surplus changed Into deficit.

Question 18. Suppose C = 100 + 0.75YΔ, I = 500, G = 750, taxes are 20% of income, X = 150, M = 100 + 0.2Y. Calculate equilibrium income, the budget deficit or surplus and the trade deficit or surplus.

Answer C=100+ 0.75YΔ
1=500
G=750
X =150
M =100 + 0.2Y

Question 19. Discuss some of the exchange rate arrangements that countries have entered into the bring about stability in their external accounts.

Answer Exchanqe rate expresses the ratio of exchange between the currencies of two countries.

Mostly three exchange rate used to bring about stability In their external accounts by countries.

1. Fixed Exchanged Rate The exchange rate that is official fixed and declared by the government.

There are two kinds of fixed exchange rate

(i) Gold Standard System As per this system gold was taken as the common unit of parity between currencies of different countries in the circulation. Each country was to define value of its currency in terms of the other currency was fixed considering gold value of each currency.
(ii) The Bretton Woods System As per this system all currencies were pegged or related to US dollar at a fixed exchange rate This system gave birth to international and monetary fund as the central institution in the international monetary system.

2. Flexible Exchange Rate The exchange rate which is determined by the forces of demand and supply of different and currencies in the foreign exchange market.

It is a flexible rate because the value of currency is allowed to fluctuate according to change in demand and supply of foreign
exchange.

3. Managed Floating Rate System The system in which the central bank allows the exchange rate to be determined by market forces but intervence at times to influence the rate. For this, central bank maintains reserves of foreign exchange to ensure that the exchange rate stays with in the targated value.

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