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Book No. – 13 (Economics)
Book Name – Introductory Macroeconomics (NCERT)
What’s Inside the Chapter? (After Subscription)
1. THE BALANCE OF PAYMENTS
1.1. Current Account
1.2. Capital Account
1.3. Balance of Payments Surplus and Deficit
2. THE FOREIGN EXCHANGE MARKET
2.1. Foreign Exchange Rate
2.2. Determination of the Exchange Rate
2.3. Merits and Demerits of Flexible and Fixed Exchange Rate Systems
2.4. Managed Floating
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LANGUAGE
Open Economy Macroeconomics
NCERT
Chapter – 6
Table of Contents
- An open economy interacts with other countries through various channels, unlike a closed economy which has no linkages with the rest of the world.
- There are three ways in which linkages are established:
- Output Market: An economy can trade in goods and services with other countries, expanding the choice for consumers and producers between domestic and foreign goods.
- Financial Market: An economy can buy financial assets from other countries, allowing investors to choose between domestic and foreign assets.
- Labour Market: Firms can choose where to locate production, and workers can choose where to work, though immigration laws often restrict labour movement between countries.
- Movement of goods is often seen as a substitute for the movement of labour.
- Foreign trade influences Indian aggregate demand in two ways:
- When Indians buy foreign goods, the spending is a leakage from the circular flow of income, decreasing aggregate demand.
- Exports to foreigners act as an injection into the circular flow, increasing aggregate demand for domestically produced goods.
- When goods move across national borders, money is required for transactions.
- At the international level, there is no single currency issued by a single bank. Foreign economic agents accept a national currency only if it maintains stable purchasing power.
- Without confidence in a currency’s purchasing power, it won’t be used as an international medium of exchange or unit of account.
- Governments have previously tried to gain confidence by making national currencies freely convertible at a fixed price into another asset, often gold or other national currencies.
- The credibility of this commitment depends on two aspects:
- The ability to convert freely in unlimited amounts.
- The conversion price of the currency.
- The international monetary system is designed to ensure stability in international transactions.
- As transaction volumes increased, gold ceased to be the asset for currency conversion.
- Some national currencies have international acceptability, but what matters in trade between two countries is the currency in which the trade occurs.
- For example, an Indian buying a good made in America needs dollars to complete the transaction.
- To complete the transaction, the Indian must know how much Indian rupees are needed for the price of the good in dollars.
- The price of one currency in terms of another is known as the foreign exchange rate or exchange rate.