NCERT Solutions Class 12 Macro Economics Chapter 6

NCERT Solutions Class 12 Macroeconomics Chapter 6- Open Economy Macroeconomics

To consider the full scope of Macroeconomics, we need to understand the position of our economy linked to the rest of the world. Most economies in today’s world are not closed economies. Countries are regularly involved in exporting and importing goods and services, financial assets and even labour. The transactions that take place between various countries would require money, and there is no single currency that works in foreign markets. The concept of foreign exchange rate thus comes into the picture. It tells the nations the price of one currency in terms of the other. The foreign exchange rate and the selling of goods, services and financial assets hugely impact the economy. It becomes imperative for the students to understand these topics to have a thorough understanding of the economy’s current situation.

The NCERT Solutions Class 12 Macroeconomics Chapter 6 prepared by Extramarks will help the students understand the crucial components of open economy macroeconomics and provide a magnified view of how such economies function. During exam preparations, examinations, or even self-study, the NCERT Solutions offered by Extramarks can be a great study resource for efficiently going through all the central topics provided in the NCERT texts.

It is suggested that students read the NCERT Solutions, which can assist them in understanding all of the important concepts covered in the chapter. Students may find it difficult to get these trustworthy and trusted answers. Extramarks has produced NCERT Solutions Class 12 Macroeconomics Chapter 6 to address this issue and ensure that students grasp and learn the chapter material. With their extensive economics knowledge, industry specialists produce these answers, so students can use them without being concerned about their authenticity.

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Along with the NCERT Solutions Class 12 Macroeconomics Chapter 6, the Extramarks website also provides several other study aids. There are NCERT books, CBSE study manuals, practice examinations, exam questions from past years and more.

Key Topics Covered in NCERT Solutions Class 12 Macroeconomics Chapter 6

Open-Economy Macroeconomics provides students with many insights on topics essential to an open economy’s operations. Students will thoroughly understand the topics related to the balance of payments, foreign exchange markets and exchange rates. Having insights into these will also make them better understand the situation in the Indian economy. The NCERT Solutions Class 12 Macroeconomics Chapter 6 is built in an easy-to-understand manner so that students can efficiently understand these primary contents in the chapter with no hassles.

Some key topics covered in NCERT Solutions Class 12 Macroeconomics Chapter 6 are as follows:

  • Open Economy
  • Balance of Payments
  • Components of BOP or Balance of Payments
  • Balance of Trade
  • BOP Deficit
  • Autonomous and Accommodating Transactions
  • Errors and Omissions
  • Foreign Exchange Market
  • The Sources of Demand and Supply of Foreign Exchange
  • System of Exchange Rate
  • Fixed Exchange Rate
  • Merits and Demerits of Fixed Exchange Rate
  • Flexible Exchange Rate
  • Merits and Demerits of Flexible Exchange Rate
  • Determination of Equilibrium
  • Managed Floating

Let us now look at the detailed information on each of the above-listed subtopics in the NCERT Solutions Class 12 Macroeconomics Chapter 6:

Open Economy

An open economy engages in multiple types of interactions with other countries. In actuality, most modern economies are open. Economies can make these connections in one of three ways:

  1. Output Market: An economy can engage in international trade in products and services. As a result, consumers and producers have a wider range of domestic and imported items to choose from.
  2. Financial Market: An economy can frequently purchase financial assets from other nations. Investors now have a choice between domestic and international assets.
  3. Labour Market: Firms can select where to place production, and employees can choose where they want to work. Several immigration regulations regulate the flow of labour between nations.

Balance of Payments

The Balance of Payments, or BoP, is a report or statement of all financial and economic transactions carried out between a nation and the rest of the world over a specific period (every quarter or year). These records contain transactions made by the government, businesses, and people. The country can monitor the movement of money and create policies that would aid in developing a robust economy by keeping track of these transactions.

Components of BOP or Balance of Payments

There are two components of a balance of payments account. Still, per the new accounting standards of the International Monetary Fund, the balance of payments has been reclassified and split into three accounts: the current, financial and capital accounts. India has likewise implemented the shift; however, the Reserve Bank of India still publishes data using the old classification.

The components of BOP, as mentioned in the NCERT Solutions Class 12 Macroeconomics Chapter 6, are given below:

  1. Current Account: The current account keeps track of how much money is exchanged between countries through trade in commodities and services (import and export). Included here are funds obtained or used for produced goods and raw materials. It also includes revenues from transportation, tourism, specialized services (such as engineering, law, and medicine) and royalties from patents and copyrights. Additionally, stock dividend income is included in the current account.

The components of the current account are as follows:

  • Balance of Trade is the difference between a country’s total product exports and imports over a given period. The export of goods is recorded as a credit in the BOT, whereas the import of goods is recorded as a debit. Alternatively, it is known as the Trade Balance.
  • Balance of Invisibles: The balance of invisible is the difference between a country’s unseen exports and imports over a given period. There are many examples of invisible, including services, transfers and income transfers between nations.
  1. Capital Account: The Capital Account keeps track of all foreign assets transactions. Any form of wealth that may be owned, including cash, stocks, bonds, government debt, and so forth, is referred to as an asset. The capital account shows the asset purchase as a debit item.

The components of the capital account are as follows:

  • Investments:
  1. Direct Investment: Foreign portfolio investment is the purchase of foreign securities, such as stocks and bonds, on an exchange.
  2. Portfolio Investment: Foreign direct investment is the purchase or construction of enterprises and associated infrastructure in another country.
  • External Borrowing: Includes Short-term Debt and External Commercial Borrowings.
  • External Assistance: Multilateral and Bilateral Loans, Government Aid, Inter-governmental Aid.

BOP Deficit

  • In a country with a balance of payments deficit, imports exceed exports of goods, capital and services. It must take foreign exchange from other countries to pay for its imports.
  • When total payments exceed total receipts, the balance of payments is in deficit; hence, BOP = Credit < Debit.
  • The government can correct a balance of payments deficit through an official reserve agreement, which denotes the Reserve Bank selling foreign currency.

Autonomous and Accommodating Transactions

Autonomous Transactions

  • Autonomous transactions occur in the global economy for purposes other than closing the balance of payments imbalance.
  • One purpose could be to make money. These goods are referred to as “above the line” items in the balance of payment.
  • This type of transaction is not subject to the condition of the payment account’s balance.
  • Autonomous items reference foreign economic transactions that occur as a result of a specific economic goal, such as profit maximisation.

Accommodating Transactions

  • The accommodating transactions are usually referred to as “below the line” items, depending on the balance of payments deficit or whether there is a deficit or surplus in the balance of payments. In other words, they are determined by the net consequences of autonomous transactions.
  • Repaying capital exchanges that are used to address the disequilibrium in the balance of payments, i.e., the autonomous items, are referred to as accommodating transactions.
  • If the balance of payments has a surplus or deficit, accommodating transactions are carried out  to balance the surplus or deficit.

Errors and Omissions

  • Keeping thorough records of all overseas transactions is challenging. As a result, in addition to the current and capital accounts, there is a third component of the balance of payment that reflects this: errors and omissions.
  • Most of the entries produced under this heading deal with leads and lags in the description of exchanges.
  • It is a balancing entry meant to offset any overstated or understated components.

Foreign Exchange Market

  • The market where different national currencies are traded is known as the foreign exchange market.
  • The main players in the foreign currency market include commercial banks, foreign exchange brokers, other authorised dealers and monetary authorities.
  • Foreign exchange markets were the first and most established financial markets, and they continue to be the foundation upon which the rest of the financial architecture is built. It provides worldwide liquidity while attempting to maintain reasonable stability.

The Sources of Demand and Supply of Foreign Exchange

Sources of Demand for Foreign Exchange

  • To buy goods and services from other countries.
  • To send gifts and grants abroad.
  • To buy financial assets from a particular country.
  • To go on foreign tours around the world.
  • For speculation on foreign currencies.

As the flexible exchange rate increases, the demand for foreign currency decreases and vice versa.

Sources of Supply of Foreign Exchange

  • For direct purchase and investment by foreigners in our country’s domestic market.
  • Remittances sent by non-residents staying in a different country.
  • Speculative purchases by the NRI or non-resident Indians.
  • Export of goods and services.
  • FDI and FPI flowing into the country from the rest of the world.

As the flexible exchange rate rises, the supply of foreign currency increases and vice versa.

System of Exchange Rate

The price of one currency is known as the foreign exchange rate (also known as the forex rate). It links the currencies of several nations and allows for price and cost comparisons across borders.

There are two kinds of exchange rates, as mentioned in the NCERT Solutions Class 12 Macroeconomics Chapter 6:

  1. Fixed Exchange Rate.
  2. Flexible Exchange Rate.

Fixed Exchange Rate

  • In this exchange rate regime, the government fixes the exchange rate at a specific level. A fixed exchange rate system’s objective is to keep the value of a currency within a specific range.
  • The devaluation occurs in a fixed exchange rate system when a government decision raises the exchange rate, causing the domestic currency to become cheaper.
  • A revaluation occurs in a fixed exchange rate system when the government lowers the exchange rate, increasing the cost of the domestic currency.

Merits and Demerits of Fixed Exchange Rate

Merits of the fixed exchange rate:

  • The stability of the exchange rate are maintained.
  • Under a fixed exchange rate, there is no place for speculation.
  • It promotes global trade and capital mobility.
  • The fixed exchange rate draws in international investment to the domestic country.
  • It necessitates the government to control inflation.

Demerits of the fixed exchange rate:

  • There are no automatic adjustments for monetary standards that become under or overvalued about the balance of payments.
  • It requires a sizeable stock of reserves to support a nation’s currency if it is put under pressure.
  • It may result in either an undervalued or an overvalued currency.
  • It contradicts the objective of free markets.

Flexible Exchange Rate

  • This exchange rate is governed by the market forces of supply and demand. It is also known as a floating exchange rate.
  • The price of foreign currency (the dollar) in terms of local currency (the rupee) has increased, as indicated by an increase in the exchange rate. Depreciation of the indigenous currency (rupees) in terms of foreign currency is what this is known as (dollars).
  • When the price of domestic currency (rupees) rises relative to foreign currency (dollars), the domestic currency (rupees) is said to have appreciated (dollars).

Merits and Demerits of Flexible Exchange Rate

Merits of flexible exchange rate:

  • Foreign exchange reserves are not necessary to maintain.
  • The “balances of payments” are consequently automatically modified.
  • To remove barriers to capital and commerce transactions.
  • It increases the effectiveness of resource allocation.
  • It resolves the problem of undervaluation or overvaluation of currencies.
  • It promotes venture capital based on foreign exchange.

Demerits of flexible exchange rate:

  • It results in future exchange rate variations
  • The flexible exchange rate is a hindrance to foreign investment and trade.
  • A flexible exchange rate encourages speculation.
  • It increases market uncertainty.

Determination of Equilibrium

The exchange rate at which supply and demand for foreign currency are equal is known as the equilibrium rate. A free market is determined by market factors, such as supply and demand for foreign currency. There is an inverse link between the demand for foreign currency and the exchange rate. The supply of foreign currency and the exchange rate are directly correlated. The supply curve is slanted upward while the demand curve is sloping downward due to the factors mentioned. The intersection of the supply and demand curves yields a graphic representation of the equilibrium foreign exchange rate.

Managed Floating

It is a hybrid of a floating exchange rate system (the float) and a fixed rate system (the managed component). When central banks intervene under this system, also known as dirty floating, they buy and sell foreign currencies to control exchange rate movements. Therefore, the number of official reserve transactions is not zero. With this exchange rate system, a nation’s central bank can regularly interfere in foreign exchange markets to restrain exchange rate changes as judged necessary.

NCERT Solutions Class 12 Macroeconomics Chapter 6: Exercise and Solution

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Key Features of NCERT Solutions Class 12 Macroeconomics Chapter 6

The NCERT Solutions Class 12 Macroeconomics Chapter 6 offers students clear, understandable content that will enable them to explore further the ideas and concepts covered in class. The NCERT Solutions Class 12 Macroeconomics Chapter 6 is a resource that students may use to practise for upcoming tests and exams or to comprehend these ideas for their revision. However, why should they continue using this resource? The reasons for the same are given below.

Extramarks NCERT Solutions Class 12 Macroeconomics Chapter 6 on Open Economy Macroeconomics contains the following vital aspects that students must employ for an effective study session:

  • The NCERT solutions framework gives a thorough and easy overview of open economy macroeconomics topics.
  • Extramarks NCERT Solutions Class 12 Macroeconomics Chapter 6 provide in-depth answers to chapter questions that enable students to answer end-text queries and sample exam questions to assist students in becoming well-rounded in their chosen topics.
  • The materials are developed by highly qualified and experienced academics who follow the most recent NCERT textbooks to provide students with legitimate and trustworthy study material.
  • Extramarks routinely updates it’s NCERT Solutions Class 12 Macroeconomics Chapter 6 following the CBSE Board. Students can use these helpful notes in the future because most of the questions on CBSE board question papers are mainly from the NCERT.

FAQs (Frequently Asked Questions)

1. What is speculation? And how does it affect the exchange rate?

Money is an asset in any nation. Indians will desire to hold pounds if they anticipate that the British pound will appreciate compared to the rupee. Therefore, exchange rates are also impacted when individuals store foreign exchange in the hope of profiting from currency appreciation. In return, this expectation may have the following effects on the currency rate.

If the current exchange rate is Rs. 80 to the pound and investors believe that the pound would appreciate by the end of the month and be worth Rs.85, investors believe that if they give the dealer Rs. 80,000 and buy 1000 pounds, they will be able to exchange the pounds for Rs. 85,000, generating a profit of Rs. 5,000. The belief would become self-fulfilling as a result of the expectation, which would increase demand for pounds and lead to an increase in the rupee-pound exchange rate.

2. What is the relationship between income and exchange rates?

When income rises, so does consumer spending. Imported goods spending is also expected to rise. The demand curve for foreign exchange shifts to the right as imports rise. The value of the local currency is falling. Domestic exports will rise, and the supply curve of foreign exchange will shift outward if income abroad also rises. The local currency may or may not depreciate overall. Whether exports are expanding faster than imports will determine what occurs. If all other factors are equal, a nation whose total demand expands faster than the rest of the world typically sees its currency decline because imports exceed exports. The demand curve for foreign money moves more quickly than the supply curve.

Students can learn more about the foreign exchange rate with the NCERT Solutions Class 12 Macroeconomics Chapter 6