Floating or flexible exchange rate is determined by the market forces of demand and supply. In a completely floating exchange rate system, the Central Bank do not interfere in the foreign exchange market. Demand for a foreign currency increases in cases of increased imports or international travels or higher investments in securities of other countries. This increase the exchange rate and depreciates the domestic currency. Depreciation has a positive price impact on exports which increases and negative impact on imports which decreases.

What will be the impact of depreciation of domestic currency on Exports of an economy?

Exports will increase

he correct answer is Exports will increase.

Depreciation of a country's currency makes exports cheaper for foreign buyers. This is because foreign buyers need to exchange fewer of their own currency units for the same amount of the depreciated currency. As a result, demand for exports increases, and exports tend to increase.

The other options are incorrect:

• Exports will decrease: This is not true. Depreciation makes exports cheaper for foreign buyers, so demand for exports increases.
• Exports will be unaffected: This is not true. Depreciation has a positive price impact on exports, so exports tend to increase.
• Exports and imports remain the same: This is not true. Depreciation has a positive impact on exports and a negative impact on imports.

Therefore, the most appropriate answer is the one that accurately describes the impact of depreciation of a country's currency on exports: Exports will increase.