Foreign Exchange and Exchange Rate
1 Quick Explanation 1–3 min
The exchange rate is the price of one currency in terms of another.
Demand for forex comes from imports & capital outflows; supply from exports & capital inflows.
2 Detailed Notes
Definition
Definitions
- Foreign exchange: foreign currencies and financial assets denominated in foreign currencies (e.g., USD, EUR, foreign bonds).
- Exchange rate: the rate at which one currency is exchanged for another — e.g., ₹86 = $1.
Key points
Demand for foreign exchange
- To buy imports of goods and services.
- To invest abroad (capital outflows).
- To repay foreign loans / remit money.
- For foreign travel and education.
Key points
Supply of foreign exchange
- From exports of goods and services.
- From foreign investment into the country (inflows).
- From remittances and receipts of foreign aid.
Diagram
Equilibrium exchange rate
X-axis: quantity of foreign exchange; Y-axis: exchange rate. Demand curve slopes down, supply slopes up. The intersection gives the equilibrium exchange rate. This diagram is a board favourite.
Example
Effect of demand rise
If India's imports rise, demand for USD rises → rupee depreciates (needs more rupees per dollar). If exports rise, supply of USD rises → rupee appreciates.
In One Minute
Exchange rate = price of one currency in another. Demand from imports/outflows; supply from exports/inflows. Equilibrium where demand = supply.
Important for Exam
- ⭐ 1-mark: define exchange rate.
- ⭐ 3-marks: determinants of demand & supply of forex.
- ⭐ Equilibrium exchange rate diagram.
- ⭐ Effect of import rise / export rise on the rate.
Watch & Learn
Watch on YouTubeForeign Exchange Rate - One Shot - Easiest Explanation - Chapter 11 - Class 12 - Macro Economics
by Rajat Arora
Why watch? Demand, supply and the equilibrium diagram.
Open on YouTube Watch on YouTubeForeign Exchange Rate - One Shot - Easiest Explanation - Chapter 11 - Class 12 - Macro Economics
by Rajat Arora
Why watch? Diagram focused explanation.
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