Question

The price of a bag increased from \(\$8\) to \(\$12\) in the US and from \(₹400\) to \(₹480\) in India. What is the effect on the dollar in terms of exchange rate?

• A. Revaluated
• B. Appreciated
• C. Depreciated
• D. Devaluated

Hint:

To check appreciation or depreciation, first calculate the value of \(1\) unit of foreign currency. If its value falls, it depreciates. If its value rises, it appreciates.

Answer 1

The Correct Option is C

Step 1: Understanding the Concept:
The exchange rate between two currencies is often influenced by the relative price levels of goods in those countries (Purchasing Power Parity).
Step 2: Key Formula or Approach:
We can determine the value of the dollar by checking how many Indian Rupees (INR) it was worth before and after the price changes based on the cost of the bag.
Initial Exchange Rate ($ER_1$) = $\frac{Price\ in\ India}{Price\ in\ US}$
Step 3: Detailed Explanation:
1. Initial Scenario:
Price in US = \$8; Price in India = 400 INR.
Implied rate: \$1 = $\frac{400}{8} = 50$ INR.
2. Final Scenario:
Price in US = \$12; Price in India = 480 INR.
Implied rate: \$1 = $\frac{480}{12} = 40$ INR.
3. Comparison:
The value of 1 Dollar has decreased from 50 INR to 40 INR.
When a currency loses value against another in the market due to price changes or demand/supply, it is said to have depreciated.
Step 4: Final Answer:
The dollar has Depreciated because its purchasing power in terms of the Indian Rupee has fallen.