Question

Under flexible exchange rate, when the price of domestic currency in terms of foreign currency increases, it is called_______

• A. Depreciation of domestic currency
• B. Appreciation of domestic currency
• C. Devaluation of domestic currency
• D. Revaluation of domestic currency

Answer 1

The Correct Option is B

In a flexible exchange rate system, market forces, specifically supply and demand against other currencies, dictate a currency's value. An increase in the domestic currency's price in foreign currency terms signifies that less foreign currency is now required to acquire the same quantity of domestic currency. This phenomenon is known as the appreciation of the domestic currency.

Let's clarify this concept:

1. Exchange Rate: The exchange rate represents the value of one currency relative to another.

2. Flexible Exchange Rate System: This system relies on market dynamics to set exchange rates, largely free from government or central bank intervention.

3. Appreciation Example: Consider an exchange rate shift from 1 USD = 50 INR to 1 USD = 45 INR. In this case, the domestic currency (INR) has appreciated against the USD. The INR has strengthened because fewer units are now needed to purchase one USD.

This explanation confirms that the correct answer is Appreciation of domestic currency.