What do you mean by flexible exchange rate system ? How the equlibeium rate detremind by flexible exchange rate system? Give the answer?
Answers
Answer:
Under the flexible exchange rate system, exchange rate between different currencies, like the prices of commodities are freely determined by market forces, that is, by demand and supply forces.
With the change in economic conditions underlying demand and supply, the exchange rate will automatically change without any intervention by the Government. That is why, it is called flexible or variable exchange rate system.
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It has the following merits:
1. Problems of Undervaluation and Overvaluation are Avoided:
The advocates of flexible exchange rates contend that under it the problems of undervaluation and overvaluation of currencies which are found in the fixed exchange rate system are avoided. Whenever there is deficit in balance of payments implying overvaluation of the national currency under the flexible exchange rates, it will depreciate (that is, its value will fall) which on the one hand will make exports cheaper and thereby encourage them and on the other will make the imports costlier than before which will tend to discourage them. Thus, increase in exports and decline in imports as a result of depreciation will lead to the automatic correction in the balance of payments.
On the other hand, whenever there is surplus in the balance of payments, the exchange rate will appreciate which will tend to reduce exports and raise imports. This again will tend to automatically restore the balance of payments equilibrium.
This is how the flexible exchange system works to ensure the equilibrium in the balance of payments. To quote Prof. Soderston, “The same factors which under the fixed rates give rise to deficits and surpluses in the balance of payments would under floating rates make the exchange rate depreciate or appreciate. Thereby equilibrium would be preserved and the Government could be freed from consideration regarding external balance”.
Explanation:
Answer:
Under the flexible exchange rate system, exchange rate between different currencies, like the prices of commodities are freely determined by market forces, that is, by demand and supply forces.
With the change in economic conditions underlying demand and supply, the exchange rate will automatically change without any intervention by the Government. That is why, it is called flexible or variable exchange rate system.
ADVERTISEMENTS:
It has the following merits:
1. Problems of Undervaluation and Overvaluation are Avoided:
The advocates of flexible exchange rates contend that under it the problems of undervaluation and overvaluation of currencies which are found in the fixed exchange rate system are avoided. Whenever there is deficit in balance of payments implying overvaluation of the national currency under the flexible exchange rates, it will depreciate (that is, its value will fall) which on the one hand will make exports cheaper and thereby encourage them and on the other will make the imports costlier than before which will tend to discourage them. Thus, increase in exports and decline in imports as a result of depreciation will lead to the automatic correction in the balance of payments.
On the other hand, whenever there is surplus in the balance of payments, the exchange rate will appreciate which will tend to reduce exports and raise imports. This again will tend to automatically restore the balance of payments equilibrium.
This is how the flexible exchange system works to ensure the equilibrium in the balance of payments. To quote Prof. Soderston, “The same factors which under the fixed rates give rise to deficits and surpluses in the balance of payments would under floating rates make the exchange rate depreciate or appreciate. Thereby equilibrium would be preserved and the Government could be freed from consideration regarding external balance”.
Explanation: