Assertion (A): Under a flexible exchange rate, a rise in the price of foreign exchange may not raise the supply of foreign exchange.
Reason (R): Whether the supply of foreign exchange actually increases depends on a number of factors, particularly the elasticity of demand for exports and imports.
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Both (A) and (R) are true and (R) is the correct explanation of (A).
Assertion (A): Under a flexible exchange rate, a rise in the price of foreign exchange may not raise the supply of foreign exchange. — True. A higher price of foreign exchange makes Indian goods cheaper for foreigners, so exports rise. But each unit exported now earns fewer dollars, so the dollars received need not rise.
Reason (R): Whether the supply of foreign exchange actually increases depends on a number of factors, particularly the elasticity of demand for exports and imports. — True. The book leaves the outcome open and names the elasticity of demand for exports and imports as the main factor.
Why R explains A?
The supply of foreign exchange rises only if foreigners buy enough more Indian goods to make up for the lower dollar price of each unit. How strongly they respond is the elasticity of demand. If the response is weak, the supply of foreign exchange may not rise, which is what A says.
NCERT (2026-27): “Supply of Foreign Exchange Foreign currency flows into the home country due to the following reasons: exports by a country lead to the purchase of its domestic goods and services by the foreigners; foreigners send gifts or make transfers; and, the assets of a home country are bought by the foreigners. A rise in price of foreign exchange will reduce the foreigner’s cost (in terms of USD) while purchasing products from India, other things remaining constant. This increases India’s exports and hence supply for foreign exchange may … increase (whether it actually increases depends on a number of factors, particularly elasticity of demand for exports and imports.” |