Question

Choose the correct statements regarding the exchange rate system: \[ (A)\ \text{In a floating exchange rate system, the exchange rate is determined by market forces of demand and supply.} \] \[ (B)\ \text{In a fixed exchange rate system, making the domestic currency cheaper is called devaluation.} \] \[ (C)\ \text{An increase in the exchange rate implies that the price of foreign currency has increased, which is called depreciation.} \] \[ (D)\ \text{Exchange rates between two currencies adjust to reflect differences in price levels in the two countries.} \]

• A. (A), (B) and (C) only
• B. (A), (B) and (D) only
• C. (B), (C) and (D) only
• D. (A), (B), (C) and (D)

Hint:

Depreciation happens in a floating exchange rate system, while devaluation happens in a fixed exchange rate system when the government officially reduces the value of domestic currency.

Answer 1

The Correct Option is D

Step 1: Understanding the Concept:
This question tests definitions related to Floating (Flexible) and Fixed exchange rate systems and the terminology of currency value changes.
Step 2: Detailed Explanation:
1. Statement (A): True. Floating exchange rates are "market-determined" based on forex demand and supply.
2. Statement (B): True. In a fixed system, when the government intentionally lowers the value of its currency, it is technically termed Devaluation.
3. Statement (C): True. If the exchange rate increases (e.g., from \$1 = 70 INR to \$1 = 80 INR), it means the Rupee has become cheaper and the Dollar more expensive. This is Depreciation of the domestic currency.
4. Statement (D): True. This refers to the theory of Purchasing Power Parity (PPP), which states that exchange rates move to equalize the price of a basket of goods across countries.
Step 3: Final Answer:
All provided statements (A, B, C, and D) are correct according to macroeconomic principles.