Read the following statements:
Statement I: In the open economy model, exports are treated as exogenous because they depend on foreign income.
Statement II: The real exchange rate is taken as fixed because price levels and the nominal exchange rate are assumed to be constant.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Both Statement I and Statement II are true.
Statement I: In the open economy model, exports are treated as exogenous because they depend on foreign income. — True. Our exports are the imports of other countries, so they depend on foreign income. That income is decided outside our economy, so exports are taken as given.
Statement II: The real exchange rate is taken as fixed because price levels and the nominal exchange rate are assumed to be constant. — True. The real exchange rate is the relative price of foreign goods in terms of domestic goods. If both price levels and the nominal rate stay the same, this relative price cannot change.
NCERT (2026-27): “DETERMINATION OF EQUILIBRIUM INCOME IN OPEN ECONOMY … 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. Exports depend positively on foreign income and the real exchange rate. Thus, exports and imports depend on domestic income, foreign income and the real exchange rate. We assume price … levels and the nominal exchange rate to be constant, hence R will be fixed. From the point of view of our country, foreign income, and therefore exports, are considered exogenous …” “… Recall that the real exchange rate is defined as the relative price of foreign goods in terms of domestic goods. …” |