In which of the following situations is the domestic currency said to have depreciated?
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → The price of foreign currency in terms of domestic currency rises through market forces in a flexible exchange rate system.
In a flexible system, a currency depreciates when more of it is needed for one unit of foreign currency, as when the dollar goes from Rs 50 to Rs 70.
Option (1) The price of domestic currency in terms of foreign currency rises through market forces in a flexible exchange rate system. — Incorrect. This is appreciation of the domestic currency.
Option (2) The price of foreign currency in terms of domestic currency rises through market forces in a flexible exchange rate system. — Correct. The dollar costs more rupees, so the rupee has lost value.
Option (3) The government raises the exchange rate in a fixed exchange rate system. — Incorrect. A rise in the rate by government action under a fixed system is devaluation.
Option (4) The government lowers the exchange rate in a fixed exchange rate system. — Incorrect. This is revaluation.
Depreciation and devaluation both make the rupee cheaper; the market causes the first, the government the second.
NCERT (2026-27): “Flexible Exchange Rate … Increase in exchange rate implies that the price of foreign currency (dollar) in terms of domestic currency (rupees) has increased. This is called Depreciation of domestic currency (rupees) in terms of foreign currency (dollars).” “Fixed Exchange Rates … 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.” |