2nd PUC Economics Question Bank Chapter 12 Open Economy Macroeconomics

You can Download Chapter 12 Open Economy Macroeconomics Questions and Answers, Notes, 2nd PUC Economics Question Bank with Answers Karnataka State Board Solutions help you to revise complete Syllabus and score more marks in your examinations.

Karnataka 2nd PUC Economics Question Bank Chapter 12 Open Economy Macroeconomics

2nd PUC Economics Open Economy One Mark Questions and Answers

Question 1.
What is closed economy?
Answer:
A closed economy is that which does not have any trade links with other countries of the world. It completely prohibits the import and export trade.

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Question 2.
Give the meaning a foriegn trade.
Answer:
Foriegn trade refers to trade between 2 or more countries.

Question 3.
Write the meaning of open economy?
Answer:
An open economy is that economy which has all kinds of economic relations with other countries of the world. It allows exports and import trade.

Question 4.
What is Balance of Trade?
Answer:
Balance of Trade refers to the difference between the value of visible items of exports and imports, during a particular period of time.

Question 5.
Give the meaning of exchange rate.
Answer:
The exchange rate refers to the rate at which the currency of one country is exchanged for currency of another country.

Question 6.
What is Flexible Exchange Rate?
Answer:
The Flexible Exchange Rate is that exchange rate which keeps on changing. This type of exchange is determined by market forces of demand and supply.

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2nd PUC Economics Open Economy Two Marks Questions and Answers

Question 1.
State the differences between Closed and Open Economies.
Answer:

Closed Economy

Open Economy

(i) A closed economy is that which does not have any trade links with other countries of the world. (i) An open economy is that economy which has all kinds of economic relations with other countries of the world.
(ii) It completely prohibits import and export trade. (ii) It allows for export and import trade.
(iii) It is policy of protection which between domestic and foreign goods. (iii) It is free trade policy and allows the inflow and outflow of foreign direct investment. (FDI)

Question 2.
What is meant by multilateral trade?
Answer:
Multilateral trade refers to that type of trade in which three or more groups of countries are involved in trade. Trade activities take place among the nations without any discrimination. Here all countries are treated equally.

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Question 3.
Differentiate between Balance of Trade and Balance of Payments.
Answer:

Balance of Trade

Balance of Payments

(i) It refers to the difference between the value of exports and imports of only visible items, during a particular period of time. (i) It refers to difference between the value of exports and imports of both visible and invisible items, during a particular of time.
(ii) It is a narrow concept. (ii) It is a broader concept.
(iii) It may not show the international economic position of an economy. (iii) It shows the international economic position of the country.
(iv) It gives partial picture of international transactions. (iv) It gives a complete picture of international transactions.

Question 4.
Distinguish between Nominal and Real Exchange rates.
Answer:

Nominal Exchange rate

Real Exchange rate

(i) It is expressed in terms of money. (i) It is the ratio of foreign prices to domestic prices.
(ii) It is the amount of domestic currency paid to purchase one unit of foreign currency. (ii) It is expressed in terms of purchasing power of both the currencies.

Question 5.
What do you mean by fixed exchange rate?
Answer:
The fixed exchange rate is that exchange rate which is fixed by the monetary authority. Any deviation from the predetermined level of exchange rate would be corrected by the immediate intervention of the Central Bank.

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2nd PUC Economics Open Economy Five Marks Questions and Answers

Question 1.
Explain the structure of balance of payments.
Answer:
The structure of India’s balance of payments is divided in to two parts.
(1) Current account and
(2) Capital account.

(1). Current account: All transactions relating to trade in goods, services and unilateral transfers are the part of Balance of payment on current account. It refers to the statement of country’s exporting of goods and services with all other countries in the world for specific period.

(a) Visible or merchandise trade relating to imports and exports: Visible or merchandise trade relating to imports and exports is an important item in current account. All those transactions in goods only are included in this.

(b) Invisible exports and imports: Invisible exports and imports includes all those trading activities relating to services (Insurance, transport, banking, etc)

(c) Unilateral transfers: Unilateral transfers are part of current account includes donations, gifts, foreign aid, etc.

The structure of current account in Balance of Payment is as follows
Current account

Items

Items

(i) Merchandise Trade – Goods and exported to other countries. (i) Merchandise trade – Goods imported from other countries
(ii) Invisibles – Services exported. (ii) Invisibles- Services imported.
(iii) Unilateral receipts – gifts donations received from other countries. (iii) Unilateral payments – gifts, donations paid to other countries.

(2). Capital Account: The capital account in the balance of payment consists of all the financial transactions in assets of lending and borrowing for both short term and long term. It relates to movement of international capital having maturity of at-least one year. It shows the flow of international loans and investments and reflects the changes in country’s foreign assets and liabilities. Private and Government transactions are two types of transactions. Direct investments, portfolio and short term investments are in private transactions. Loans to and from foreign official agencies are in Government transactions.

To sum up, the Current Account includes the following

  • Short term Capital Movements and
  • Long term Capital Movements

Capital account

Particulars

Particulars

(i) Loans and advances borrowed from other countries and Foreign Direct Investments

Repayment of loans from foreign countries

(i) Loans and advances given to other countries and direct investment in other countries.

Repayment of loans to foreign countries

(ii) Sale of gold/assets (ii) Purchase of gold/assets

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Question 2.
Explain the theories of determination of exchange rate.
Answer:
There are two important theories which explain the determination of exchange rate viz.,

  1. The Purchasing Power Parity Theory (PPP)
  2. The Balance of Payment Theory.

(1) The Purchasing Power Parity Theory: The purchasing power parity theory was advocated by the Swedish Economist Gustav Cassel. According to this theory, equilibrium exchange rate between two inconvertible paper currencies is determined by the equality of their purchasing power. In other words, the rate of exchange between two countries is determined by their relative price levels.

According to the theory, the exchange rate between two countries is determined at a point which expresses the equality between the respective purchasing powers of the two currencies. This is the purchasing power parity which is a moving par and not a fixed par as under the gold standard. Thus with every change in the price level, the exchange rate, also changes. To calculate the new equilibrium exchange rate, the following formula is used:

2nd PUC Economics Question Bank Chapter 12 Open Economy 1

(b) Balance of payments theory: According to this theory, the foreign exchange rate, under free market conditions, is determined by the conditions of demand and supply in the foreign exchange market. Under free exchange rates, the exchange rate of the currency of a country depends upon its balance of payments. A favourable balance of payments raises the exchange rate, while an unfavourable balance of payments reduces the exchange rate. Thus the theory implies that the exchange rate is determined by the demand for and supply of foreign exchange.

When the balance of payments is in equilibrium, the supply of and demand for the currency are equal. If the exchange rate falls below the equilibrium exchange rate in a situation of adverse balance of payments, exports increase and the adverse balance of payments is eliminated and the equilibrium exchange rate is re-established.

Under a favourable balance of payment situation, the exchange rate rises above the equilibrium exchange rate, exports decline, the favourable balance of payments disappears and the equilibrium exchange rate is re-established. Thus at any point of time, the rate of exchange is determined by the demand for and supply of foreign exchange as represented by the debit and credit side of the balance of payments.

Question 3.
What are the exchange rate systems?
Answer:
The major exchange rate systems are as follows:

(a) Flexible Exchange Rate: A flexible, floating or fluctuating exchange rates are determined by market forces. The monetary authorities do not intervene for the purpose of influencing the exchange rate. Under freely fluctuating exchange rates, if there is an excess supply of a currency, the value of that currency in foreign exchange markets will fall. It will lead to depreciation of the exchange rate. Consequently equilibrium will be restored in the exchange market.

If there is shortage of currency, it will lead to the appreciation of exchange rate and . thereby leading to restoration of equilibrium in the exchange market. These market forces
operate automatically without any action on the part of monetary authorities.

(b) Fixed Exchange Rate: It is also called pegged exchange rate. Under this type of exchange rate, all exchange transactions take place at an exchange rate that is determined by the monetary authorities. The authorities may fix the exchange rate by legislation or intervention in currency markets. They buy or sell currencies according to the needs of the country or may take policy decision to appreciate or depreciate the national currency

For instance, if there is too much fluctuation in exchange rate in exchange market, the RBI may interfere and fix the rate of exchange of foreign currencies.

(c) Managed floating system: This system of exchange rate is a mixture of flexible and fixed exchange rate systems. Here, the exchange rate is fixed by the market forces viz., demand and supply. But, the statutory monetary authority (Reserve Bank of India) determines upper and lower limit of exchange rates. When the exchange changes beyond maximum and minimum limits, the central monetary authority intervenes and brings the exchange rate will within the predetermined limits.

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2nd PUC Economics Open Economy Ten Marks Questions and Answers

Question 1.
What is Balance of Payments? Explain the structure of Balance of Payments.
Answer:
Balance of Payments refers to difference between the value of exports and imports of both visible and invisible items, during a particular duration of time. It shows international economic position of the country. It gives complete picture of international transactions.

The structure of India’s balance of payments is divided in to two parts.
(1) Current account
(2) Capital account

1. Current account: All transactions relating to trade in goods, services and unilateral transfers are the part of Balance of payment on current account. It refers to the statement of country’s exporting of goods and services with all other countries in the world for a specific period.

(a) Visible or merchandise trade relating to imports and exports: Visible or merchandise trade relating to imports and exports is an important item in current account. All those transactions in goods only are included in this.

(b) Invisible exports and imports: Invisible exports and imports includes all those trading activities relating to services (Insurance, transport, banking, etc)

(c) Unilateral transfers: Unilateral transfers are part of current account that include donations, gifts, foreign aid, etc.
The structure of current account in Balance of Payment is as follows

Items

Items

(i) Merchandise Trade – Goods and exported to other countries. (i) Merchandise trade – Goods imported from other countries
(ii) Invisibles – Services exported. (ii) Invisibles- Services imported
(iii) Unilateral receipts – gifts donations received from other countries (iii) Unilateral payments- gifts, donations paid to other countries.

(2) Capital Account: The capital account in the balance of payment consists of all the financial transactions in assets of lending and borrowing for both short term and long term. It relates to movement of international capital having maturity of at-least one year. It shows the flow of international loans and investments and reflects the changes in countries’ foreign assets and liabilities. Private and Government transactions are two types of transactions. Direct investments, portfolio and short term investments are in private transactions. Loans to and from foreign official agencies are in Government transactions.

To sum up, the Current Account includes the following

(i) Loans and advances borrowed from other countries and Foreign Direct Investments (i) Loans and advances given to other countries and direct investment in other countries.
(ii) Repayment of loans from foreign countries (ii) Repayment of loans to foreign countries
(iii) Sale of gold/assets (iii) Purchase of gold/assets

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