Balance of Payments Test - 3

More of foreign currency is supplied at higher exchange rates in forex market.

Excess demand of an entity always leads to inflation of a value. Same happens with foreign exchange.

These are those transactions that occur because of other activities like government financing.

A fixed exchange rate is a country's exchange rate regime under which the government or Central bank ties the official exchange rate to another country's currency or to the price of gold. The purpose of a fixed exchange rate system is to maintain a country's currency value within a very narrow band.

As foreign currency appreciates, imports for them become cheaper. So, they supply more foreign currency in the forex market.

A currency legal tender in the country in which it is printed and not legal tender in other country unless it is exchanged for foreign currency.

Flexible exchange rate is determined by the forces of demand and supply i.e. where demand equals supply eliminating the undervaluation or overvaluation of currencies.

We know that multiplier , K=1/mps,

Now,mps=1-mpc=1-0.8=0.2

Hence, k= 1/0.2=5

It is determined by market forces because every currency area must decide what type of exchange rate arrangement to maintain. Between permanently fixed and completely flexible however, are heterogeneous approaches. They have different implications for the extent to which national authorities participate in foreign exchange markets.

flexible exchange rates creates instablity because there is too frequent fluctuations in exchange rate under it create uncertainty about the exact amount of receipts and payments in foreign exchange transac­tions.And this instability hampers foreign trade and capital movements between the countries.