Under a fixed exchange rate system, the government changes the exchange rate from Rs 70 to Rs 77 per dollar. What is this change called, and what happens to the dollar price of an Indian good priced at Rs 1,540?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → Devaluation; the price falls from $22 to $20
In a fixed system, a government action that raises the exchange rate makes the domestic currency cheaper; this is devaluation. The dollar price of an Indian good is its rupee price divided by the exchange rate.
Given:
Exchange rate: Rs 70 → Rs 77 per dollar
Price of the good = Rs 1,540
\( \displaystyle \text{Before: } \frac{1540}{70} = 22 \text{ dollars} \)
\( \displaystyle \text{After: } \frac{1540}{77} = 20 \text{ dollars} \)
It is a devaluation, and the good becomes cheaper for foreigners: from $22 to $20.
Option (1) Revaluation; the price falls from $22 to $20 — Incorrect. A revaluation lowers the exchange rate and makes the rupee costlier. Here the rate went up.
Option (2) Devaluation; the price rises from $20 to $22 — Incorrect. More rupees per dollar means fewer dollars for the same rupee price, so the dollar price falls.
Option (4) Revaluation; the price rises from $20 to $22 — Incorrect. Both parts are reversed: the change is a devaluation, and the dollar price falls.
NCERT (2026-27): “Fixed Exchange Rates … However, let us suppose that for some reason the Indian Government wants to encourage exports for which it needs to make rupee cheaper for foreigners it would do so by fixing a higher exchange rate, say Rs 70 per dollar from the current exchange rate of Rs 50 per dollar. … In a fixed exchange rate system, when some government action increases the exchange rate (thereby, making domestic currency cheaper) is called Devaluation. On the other hand, a Revaluation is said to occur, when the Government decreases the exchange rate (thereby, making domestic currency costlier) in a fixed exchange rate system.” |