Read the following statements:
Statement I: Imports depend positively on domestic income and negatively on the real exchange rate.
Statement II: Exports depend positively on foreign income and on the real exchange rate.
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.
The real exchange rate R is the price of foreign goods in terms of domestic goods. A higher R makes foreign goods dearer and our goods cheaper.
Statement I: Imports depend positively on domestic income and negatively on the real exchange rate. — True. Higher income raises imports; a higher R makes foreign goods dearer, so imports fall.
Statement II: Exports depend positively on foreign income and on the real exchange rate. — True. Higher foreign income raises demand for our goods; a higher R makes our goods cheaper, so exports rise.
NCERT (2026-27): “National Income Identity for an Open Economy … The demand for imports depends on domestic income (Y) and the real exchange rate (R ). Higher income leads to higher imports. 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. 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.” |