The real exchange rate (R) is the relative price of foreign goods in terms of domestic goods. Other things remaining the same, a rise in R will:
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → decrease the quantity of imports
A rise in R means foreign goods become dearer compared with domestic goods. So people buy fewer imports. The same rise makes domestic goods cheaper for foreigners, so exports rise.
Option (1) decrease the exports of the country — Incorrect. A higher R makes our goods cheaper abroad, so exports increase.
Option (2) decrease the quantity of imports — Correct. Foreign goods are now relatively more expensive.
Option (3) make domestic goods dearer for foreigners — Incorrect. A higher R makes domestic goods cheaper.
Option (4) increase the quantity of imports — Incorrect. Dearer foreign goods mean fewer imports.
NCERT (2026-27): “National Income Identity for an Open Economy … Recall that the real exchange rate is defined as the relative price of foreign goods in terms of domestic goods. A higher R makes foreign goods relatively more expensive, thereby leading to a decrease in the quantity of imports. Thus, imports depend positively on Y and negatively on R. The export of one country is, by definition, the import of another. Thus, our exports would constitute of foreign imports. It would depend on foreign income, Yf , and on R. A rise in Yf will increase foreign demand for our goods, thus leading to higher exports. An increase in R, which makes domestic goods cheaper, will increase our exports. …” |