NCERT Solutions for Class 12 Macro Chapter 6 - Open Economy Macroeconomics

1. Differentiate between balance of trade and current account balance.

Ans: The term "balance of trade" refers to the difference between the export and import of visible goods (goods only). It's also known as the differential between the value of items exported and imported.

The following items are included in the current account balance:

• Goods and services export and import.
• Unilateral transfers from one country to another.
• It is the net value of the visible (goods) and invisible (services) trade / items' balances, and it records transactions for both. The concept of current account balance has broadened.

As a result, the current account balance is only considered as a part of the balance of trade.

2. What are official reserve transactions? Explain their importance in the balance of payments.

Ans: Official reserve transactions are transactions by a central bank that cause changes in its official reserve (ORT). These are usually purchases or sales of the company's own currency on the exchange market in exchange for foreign currencies or other assets denominated in foreign currencies. The purchase of its own currency is considered as a credit (+) in the balance of payment, whereas a sale is a debit (-).

The following are the reasons for the importance of ORT in the balance of payments:

1. The purchase of a country's own currency is a credit item in the balance of payments, but the sale of the currency is a debit item.
2. It aids in the adjustment of the balance of payments deficit and surplus. As a result, ORT is critical to every country's economy.

3. Distinguish between the nominal exchange rate and the real exchange rate. If you were to decide whether to buy domestic goods or foreign goods, which rate would be more relevant? Explain.

Ans: The nominal exchange rate is the price of a foreign currency expressed in local currency. The nominal exchange rate is the cost of acquiring one unit of foreign currency (say, a dollar) in terms of domestic currency (say, rupees). The exchange rate is expressed in terms of money, i.e. how many rupees per dollar. The nominal exchange rate, for example, is the price at which one American dollar can be purchased for 50 Indian rupees, or the price at which one dollar can be purchased for Rs.50. The real exchange rate is the price of imported goods relative to the price of domestic goods. Real exchange occurs when the cost of acquiring one unit of domestic currency (say, rupees) is expressed in terms of a foreign currency (say, dollar). For example, 1 rupee costs 2 cents (1 dollar=100 cents) in the example above. Visitors to America should be aware of how pricey American items are in comparison to those in their native country.

Real exchange rate $=\sqrt{\frac{P_{f}}{P}}$

Here, P - Price level of domestic currency e- Nominal exchange rate and $P_{f}$ is the Price level of the domestic currency. For example, if a watch costs $\$ 40$ in the United States and the nominal exchange rate is 50 , it should cost Rs 2,000 with a real exchange rate of

$e P_{f}=50 \times 40=\mathrm{R}=2000$

4. Suppose it takes  1.25 yen to buy a rupee, and the price level in Japan is 3 and the price level in India is 1.2. Calculate the real exchange rate between India and Japan (the price of Japanese goods in terms of Indian goods). (Hint: First find out the nominal exchange rate as a price of yen in rupees).

Ans: Price level in a foreign country: (Japan) $P_{f}=3$

The price level in home country: (India) $P=1.2$

Real exchange rate $=e \frac{P_{f}}{P}$

Price of $1.25$ yen $=1$ rupee

Price of 1 yen $=\frac{1}{1.25}=\frac{100}{125}=\frac{4}{5}$ Rupee

Therefore, $\mathrm{e}=\frac{4}{5}$ Rupee

So, real exchange rate $=e \frac{P_{f}}{P}=\frac{4}{5} \times \frac{3}{1.2}=2$

5. Explain the automatic mechanism by which BOP equilibrium was achieved under the gold standard.

Ans: Gold was used as a single unit of measurement for other countries' currencies under the gold standard system. As a result, a currency's worth was determined in terms of gold. In an open market, the exchange rate was set by its gold value. It was set in lower and upper bounds, within which it was free to fluctuate. As a result of the gold standard, the exchange rate became steady. To exchange currency, all governments retain a gold stock. The price-specie-flow mechanism proposed by David Hume is the adjustment process under the gold standard. A balance of payment imbalance will be repaired by a gold counter-flow under the gold standard. An automatic equilibrating method was used to maintain the fixed exchange rate.

6. How is the exchange rate determined under a flexible exchange rate regime?

Ans: The rate of exchange is controlled by the forces of demand and supply in the international market under a flexible exchange rate framework. In other words, when demand and supply are equal, the equilibrium rate of exchange is reached. The equilibrium rate is also set at a point when the demand for foreign exchange is equal to the supply of the same. The following diagram can assist to illustrate this:

The x-axis depicts foreign currency demand and supply, while the y-axis depicts the exchange rate. The downward-sloping demand curve (DD) depicts an inverse relationship between the rate of exchange and demand for foreign currency. The supply curve, on the other hand, is upward sloping, indicating a positive relationship between the rate of exchange and foreign currency supply. E is the exchange rate at which demand and supply of foreign currency are equal (OR). If the exchange rate climbs to OR1, the supply will outstrip the demand, leading the rate to fall back to OR. If the exchange rate falls to OR2, on the other hand, there is an excess of demand oversupply. As a result, the exchange rate rises from R2 to R., demand and supply of foreign currency determine the equilibrium exchange rate (OR). Payment of international loans, gifts, and grants are all sources of foreign exchange demand. Worldwide export, direct foreign investment, and other forms of foreign exchange supplies are examples.

7. Differentiate between devaluation and depreciation.

Ans: The difference between devaluation and depreciation are as following:

8. Would the central bank need to intervene in a managed floating system? Explain why.

Ans: A managed floating system is one in which market forces determine the foreign exchange rate. Through involvement in the international market, the central bank or government can influence the currency rate. It aids in the stabilization of exchange rates by facilitating the acquisition and sale of foreign money. It provides for exchange rate adjustments by established norms and regulations that are publicly reported in the foreign market.

1. It is a cross between a fixed and a variable exchange rate system.
2. In this system, the central bank intervenes in the foreign exchange market to keep exchange rate swings within predetermined bounds. The goal is to keep the exchange rate as near to zero as possible.
3. To do this, the central bank maintains foreign exchange reserves to ensure that the exchange rate remains within the desired range.
4. It's called 'Dirty Floating.'

9. Are the concepts of demand for domestic goods and domestic demand for goods the same?

Ans: Domestic demand for goods and domestic demand for goods are comparable concepts in a closed economy. These two phrases, however, have different meanings in an open economy.

Demand for domestic commodities comes from both domestic and international sources. Local demand for goods, on the other hand, refers to a country's domestic market demand for items produced either domestically or overseas (foreign countries).

10. What is the marginal propensity to import when M = 60 + 0.06Y? What is the relationship between the marginal propensity to import and the aggregate demand function?

Ans: The fraction of additional revenue spent on imports is known as the marginal propensity to import $M=60+0.06 Y$ is a given value.

As a result, the marginal propensity to import (m) equals 0.06. It reflects induced imports, which are a portion of total imports that are a consequence of income.

Because the marginal inclination to import harms the aggregate demand function, aggregate demand falls as income rises. Because the extra money is spent on foreign goods rather than home items, this is the case.

11. Why is the open economy autonomous expenditure multiplier smaller than the closed economy one?

Ans: $\mathrm{Y}=\mathrm{C}+\mathrm{cY}+\mathrm{I}+\mathrm{G}$

Or, $Y-c Y=C+I+G$

Or, $Y(1-c)=C+I+G$

$I=\frac{C+I+G}{1-c}$

Let, $(\mathrm{C}+\mathrm{I}+\mathrm{G})=A_{1}$

Or, $\mathrm{Y}=\frac{A_{1}}{1-c} \cdots \cdots(i)$

Or, $\frac{\Delta Y}{\Delta A_{1}}=\frac{1}{1-c}$

In the case of an open economy, the equilibrium level of income is given by

$\mathrm{Y}=\mathrm{C}+\mathrm{CY}+\mathrm{I}+\mathrm{G}+\mathrm{X}-\mathrm{M}-\mathrm{mY}$

Or $Y-c Y+m Y=C+I+G-X-M$

Or, $Y(1-c+m)=C+I+G+X-M$

$Y=(C+I+G+X-M) / 1-c+m$

$\left(A_{2}\right)=\mathrm{C}+\mathrm{I}+\mathrm{G}+\mathrm{X}-\mathrm{M}$

$\mathrm{Or}, \mathrm{Y}=\mathrm{A}_{2} / 1-\mathrm{c}+\mathrm{m}$

$\frac{\Delta y}{\left(\Delta A_{2}\right)}=\frac{1}{(1-c+m)} \cdots \ldots(i i)$

We can conclude that the multiplier in an open economy is less than the multiplier in a closed economy because the denominator in an open economy is bigger than the denominator in a closed economy by comparing equations (1) and (2) and the denominators of the two multipliers.

When compared to a closed economy, an increase in autonomous demand leads to a lesser growth in output.

12. Calculate the open economy multiplier with proportional taxes, T = tY, instead of lump-sum taxes as assumed in the text.

Ans: The equilibrium income in the case of proportional tax would be

$Y=C+c(1-t) Y+I+G+X-M-m Y$

$\Rightarrow Y-c(1-t) Y+m Y=C+I+G+X-M$

$\Rightarrow Y[1-c(1-t)+m]=C+I+G+X-M$

$Y=\frac{(C+I+G+X-M)}{[1-C(1-t)+m]}$

Autonomous expenditure $(\mathrm{A})=\mathrm{C}+\mathrm{I}+\mathrm{G}+\mathrm{X}-\mathrm{M}$ Therefore, open economy multiplier with proportional taxes.

$\frac{\Delta Y}{\Delta A}=\frac{1}{1-c(1-t)+m}$

13. Suppose $C=40+0.8 Y D, T=50, I=60, G=40, X=90, M=50+0.05 Y$

(a) Find equilibrium income

Ans: $\mathrm{C}=40+0.8 \mathrm{YD}$

$\mathrm{T}=50$

$\mathrm{I}=60$

$\mathrm{G}=40$

$\mathrm{X}=90$

$\mathrm{M}=50+0.05 \mathrm{Y}$

$Y=C+c(Y-T)+I+G+x-M-m Y$

$Y=\frac{A}{1-c+m}$

Where, $\mathrm{A}=\mathrm{C}-\mathrm{cT}+\mathrm{I}+\mathrm{G}+\mathrm{X}-\mathrm{M}$

$=\frac{C-c T+I+G+X-M}{1-c+m}$

$=\frac{40-0.8 \times 50+60+40+90-50}{1-0.8+0.05}$

$=(40-40+60+40+90-50) 0.25$

$=\frac{140}{0.25}=\frac{140}{25} \times 100$

$=560$

(b) Net exports at equilibrium income

Ans: $N X=X-M-m Y$

$=90-50-0.05 \times 560$

$=40-28=12$

(c) When G increase from 40 to 50 ,

Ans: Equilibrium income $(\mathrm{Y})=\frac{C-c T+I+G+X-M}{1-c+m}$

$=\frac{(40-0.8 \times 50+60+50+90-50)}{(1-0.8+0.05)}$

$=(40-40+60+50+90-50) 0.25$

$=\frac{150}{0.25}=\frac{150}{25} \times 100$

$=600$

Net export balance at equilibrium income NX

$X-(M+m Y)=90-50-0.05 \times 600$

$=40-30$

$=10$

14. In the above example, if exports change to $X=100$, find the change in equilibrium income and the net export balance

Ans: The given data

$\mathrm{C}=40+0.8 \mathrm{YD}$

$\mathrm{T}=50$

$I=60$

$G=40$

$X=100$

$M=50+0.05 Y$

Equilibrium income $(Y)=\frac{A}{1-c+m}$

$=\frac{C-c T+I+G+X-M}{1-c+m}$

$=\frac{40-0.8 \times 50+40+60+100-50}{1-0.8+0.05}$

$=\frac{40-40+40+60+100-50}{0.25}=\frac{150}{0.25}$

$=\frac{150 \times 100}{25}$

$=600$

$text { Net export balance } \mathrm{NX}=\mathrm{X}(\mathrm{M}-\mathrm{mY})$

$=100-50-0.05 \times 600$

$=50-0.05 \times 60$

$=50-30=20$

15. Explain why $\mathbf{G}-\mathbf{T}=\left(\mathbf{S}^{\mathbf{p}}-\mathbf{I}\right)-(\mathbf{X}-\mathbf{M})$

Ans: At the equilibrium level of income in a closed economy, savings and investments are equal. Savings and investments, on the other hand, differ in an open economy.

$Y=C+I+G+X-M$

$\Rightarrow Y=C+I+G+N X[A s N X=X-M]$

$\Rightarrow Y-C-G=I+N X \ldots . .(1)$

The LHS component can now be considered national savings. That is, the amount of money left over after consumption and government spending.

$\mathrm{S}=\mathrm{I}+\mathrm{NX}$

National Savings (S)in an economy include private savings $\left(S^{p}\right)$ and government savings

$\left(S^{s}\right)$

So, $S^{P}+S^{g}=I+N X$ $=\mathrm{NX}=S^{P}+S^{g}-I$ $\Rightarrow \mathrm{NX}=(\mathrm{Y}-\mathrm{C}-\mathrm{T})+(\mathrm{T}-\mathrm{G})-\mathrm{I}\left[\mathrm{As} S^{P}=Y-C-T\right.$ and $\left.S^{g}=T-G\right]$ $\Rightarrow \mathrm{NX}=\mathrm{Y}-\mathrm{C}-\mathrm{T}+\mathrm{T}-\mathrm{G}-\mathrm{I} \Rightarrow \mathrm{NX}=\mathrm{Y}-\mathrm{C}-\mathrm{G}-\mathrm{I}$ $\Rightarrow \mathrm{G}=\mathrm{Y}-\mathrm{C}-\mathrm{I}-\mathrm{NX}$

$\Rightarrow \mathrm{G}-\mathrm{T}=\mathrm{Y}-\mathrm{C}-\mathrm{I}-\mathrm{NX}-\mathrm{T}[$ Subtracting $\mathrm{T}$ from both sides $]$

$\Rightarrow G-T=Y-C-T-I-N X$

$\Rightarrow \mathrm{G}-\mathrm{T}=\left(\mathrm{S}^{\mathrm{P}}-\mathrm{I}\right)-\mathrm{NX}$

$\Rightarrow \mathrm{G}-\mathrm{T}=\left(\mathrm{S}^{\mathrm{P}}-\mathrm{I}\right)-(\mathrm{X}-\mathrm{M})[\mathrm{NX}=\mathrm{X}-\mathrm{M}]$

16. If inflation is higher in country A than in Country B, and the exchange rate between the two countries is fixed, what is likely to happen to the trade balance between the two countries?

Ans: The exchange rate is one of the most important determinants of a country's trade level. Inflation in country A is higher than in country B. Because the exchange rate is fixed, exporting goods to nation A benefits country B. Similarly, importing items from nation B is beneficial to country A. Exporting commodities to nation B, on the other hand, would be costly for country A. As a result, compared to country B, country A will have a trade imbalance since it will import more items than it exports. Nation B will buy fewer commodities from country A than country A sells. As a result, country B has a trade surplus.

17. Should a current account deficit be a cause for alarm? Explain.

Ans: The difference between total imports of goods, services, and transfers and total exports of goods, services, and transfers is known as the current account deficit. This is owing to excessive inflation, poor economic development, and the difficulty of exporting due to the fixed exchange rate. As a result of this predicament, a country becomes a debtor to the rest of the globe. However, this should not always be interpreted as a cause for concern, as countries may be running current account deficits to boost productivity and exports in the future. Furthermore, increased investment will aid in the development of capital stock, increasing output in the future.

18. Suppose C=100+0.75YD, I=500, G=750, taxes are 20percent of income, X=150, M= 100 + 0.2Y. Calculate equilibrium income, the budget deficit or surplus and the trade deficit or surplus.

Ans:  $\mathrm{C}=100+0.75 \mathrm{YD}$

$I=500$

$G=750$

$X=150$

$M=100+0.2 Y$

Equilibrium income $(\mathrm{Y})=\mathrm{C}+\mathrm{c}(\mathrm{Y}-\mathrm{T})+\mathrm{I}+\mathrm{G}+\mathrm{X}-\mathrm{M}-\mathrm{mY}$ Or, $Y=\mathrm{I} 00+.75\left(Y-\frac{20}{100} Y\right)+500+750+150-100-0.2 \mathrm{Y}$

$\mathrm{Or}, 1400+\frac{75}{100} \times \frac{4 Y}{5}-0.2 \mathrm{Y}$

Or, $Y=1400+\frac{3}{5} Y-0.2 \mathrm{Y}$

$\mathrm{Y}=1400+2 \mathrm{Y} / 5$

$\mathrm{Y}-2 \mathrm{Y} / 5=1400$

Or, $3 \mathrm{Y} / 5=1400$

Or, $Y=1400 \times 5 / 3=7000 / 3$

Government expenditure $=750$

Government receipts(taxes) $=\frac{20}{100} \times \frac{7000}{3}=\frac{1400}{3}=466.6$

Since, government expenditure > government receipts, It shows the government is running on deficit budget. $\mathrm{NX}=\mathrm{X}-\mathrm{M}-\mathrm{mY}$

$=150-100-0.2 \times 7000 / 3$

$=150-100-1400 / 3$

$=150-100-466.66$

$=150-566.66$

$=-416.66$

It is a trade deficit, because the value of $\mathrm{NX}$ is negative.

Or, $3 \mathrm{Y} / 5=1400$

Or, $Y=1400 \times 5 / 3=7000 / 3$

Government expenditure $=750$

Government receipts(taxes) $=\frac{20}{100} \times \frac{7000}{3}=\frac{1400}{3}=466.6$

Since, government expenditure > government receipts, It shows the government is running on deficit budget. $\mathrm{NX}=\mathrm{X}-\mathrm{M}-\mathrm{mY}$

$=150-100-0.2 \times 7000 / 3$

$=150-100-1400 / 3$

$=150-100-466.66$

$=150-566.66$

$=-416.66$

It is a trade deficit, because the value of $\mathrm{NX}$ is negative.

19. Discuss some of the exchange rate arrangements that countries have entered into to bring about stability in their external accounts.

Ans: To combine the two extreme positions of ‘fixed' and ‘flexible,' governments utilize the following exchange rate arrangements to ensure stability to their external accounts:

i. Wider Bands: Wider bands refer to a method that allows for changes in a fixed exchange rate. It only allows for a 10% difference in currency values between any two countries. For example, a country's balance of payments (BOP) deficit can be reduced by devaluing its currency, which increases demand for local goods as the purchasing power of foreign currencies rises. This results in a rise in exports, which improves the BOP.

ii. Crawling Peg: The crawling peg system provides for continual and regular exchange rate modifications. At any given time, just 1% fluctuation is permitted.

iii. Managed floating: Managed floating is a program in which the government intervenes to modify the exchange rate when circumstances need it.

As with crawling pegs and wider bands, there is no set limit to variation.

The rate at which one currency is exchanged for another is referred to as an exchange rate in finance.

The float, fixed-rate, and pegged float exchange rate systems are the three basic types of exchange rate systems.

• Floating exchange rate: Also referred to as a floating exchange rate. A system in which the value of a currency about other currencies is permitted to vary freely according to market forces. A floating currency, such as the dollar, is an example. Floating exchange rates, according to many economists, are the greatest conceivable exchange rate regime since they naturally react to economic conditions.

• Fixed exchange rate system: A fixed exchange rate system is also known as a pegged exchange rate system. A system in which the value of a currency is linked to the value of another single currency, a basket of currencies, or another monetary metric, such as gold. A country's central bank is always committed to buying and selling its currency at a predetermined price. The gold standard is the most well-known fixed rate system, in which a unit of currency is linked to a set amount of gold. The Bretton Woods System, in which all currencies are tied or linked to the US dollar, is the second key one. China's fixed exchange rate is well-known. It was one of the few countries that could establish a fixed rate by making trading its currency at any other rate unlawful.

• Pegged float exchange rate: A currency system in which the exchange rate is fixed around a specific value but allows for fluctuations, usually within set limits. These regimes are a mix of fixed and floating. Crawling bands, crawling pegs, and pegged with horizontal bands are the three forms of pegged float regimes.

Managed Floating, often known as dirty floating, is another popular exchange rate nowadays. It's a hybrid of a floating exchange rate system and a fixed rate system (the float component) (the managed part). It's best described as a system in which exchange rates are permitted to vary within a set range from day to day before the central bank intervenes to alter them.

Class 12 NCERT Solutions Macro Economics - Open-Economy Macroeconomics

Students often find this topic difficult hence they look for solutions to the end-of-chapter problems. They should prepare this topic well for the class 12 board exam since it has considerable marks weightage. The concepts covered in this chapter are relatively advanced, hence require greater clarity.

Ch 6 macroeconomics class 12 deals with the concept of the Open Economy of any country. An open economy refers to the various links that are established between the economies of many nations.

Economics Class 12 Chapter 6 Macroeconomics

Let us take a look at some of the key topics covered in this chapter.

The key concepts covered in this chapter are given below.

1. Fixed exchange rate.

2. Devaluation.

3. Managed floating.

4. Demand for domestic goods.

5. Marginal propensity to import.

6. Net exports.

7. Purchasing power parity.

8. Flexible exchange rate.

9. Depreciation.

10. Interest rate differential.

11. Open economy multiplier.

12. Open economy Balance of payments.

13. Current account deficit.

14. Official reserve transactions.

15. Autonomous and accommodating transactions.

16. Nominal and real exchange rate.

Given the sheer volume, it is understandable that students may have great difficulty in studying this chapter. Due to this fact, it useful to download the solution set for the questions given at the end of this chapter.

Students will significantly benefit from it. It is worthwhile for easy revision and general usefulness. Usually, the solutions to the questions given at the end of this chapter helps students to understand and memorize the relevant points of the chapter.

NCERT Solutions for Class 12 Macroeconomics Chapter 6

Ch 6 macroeconomics class 12 is not so easy to understand on your own. It would help if you have the guidance of the NCERT Solutions to the end-of-chapter exercises. However, it must be ensured that the questions are solved meticulously and in a systematic manner. Being consistent is extremely important in this regard. Vedantu has come up with an appropriate and useful solution to the challenges faced by the students.

Economics class 12 chapter 6 macroeconomics solution set will provide you with a sure-fire solution to all your woes of the chapter 6 of macroeconomics class 12.

Macroeconomics Chapter 6 Class 12 PDF Solutions

The NCERT Solutions provided by Vedantu has many features that will be beneficial to the students. These features are given below.

• Written in simple language.

• Detailed worked out sums.

• Accurate solutions.

• Easy to understand answers.

• Use of comparison tables.

• Step-by-step approach to all answers.

Take a look at some of the solutions, and you will have a clear picture of how useful these solutions are. The solutions will also help you to have a better understanding of the topics covered in this chapter. Here is an example of a solution.

Question: Differentiate between Devaluation and Depreciation.

Solution:

Benefits of NCERT Solutions for CBSE Class 12 Macroeconomics Chapter 6 

• NCERT Solutions for CBSE Class 12 Macroeconomics Chapter 6 helps students to gain an in-depth understanding of the topic.

• These solutions are also effective for preparing for other competitive exams.

• The difficult concepts of the chapter are explained in these solutions to facilitate easy learning.

• Solving the NCERT Solutions for  CBSE Class 12 Macroeconomics Chapter 6 helps students to analyse their weaker areas and provide additional guidance to understand the chapter concepts precisely.

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One needs to have thorough practice of ch 6 macroeconomics class 12 to secure good grades in the examination. When students are done going through the NCERT Solutions they can also revise the previous years’ question papers. All said and done, macroeconomics chapter 6 class 12 PDF will be of massive help to students preparing for their class 12 boards this year. So download and refer to the NCERT Solutions to economics class 12 chapter 6 macroeconomics for free from Vedantu and revise all the concepts for your Class 12 board examination.

Conclusion 

NCERT Solutions for Class 12 Macro Chapter 6 - Open Economy Macroeconomics offer a comprehensive and detailed understanding of the complexities of an open economy's macroeconomic aspects. These solutions provide step-by-step explanations, practical examples, and graphical representations that aid students in grasping the intricacies of international trade, balance of payments, exchange rates, and their impact on a country's economy. By engaging with these solutions, students can develop a deeper insight into the functioning of an open economy and the interplay of various economic variables. NCERT Solutions for Class 12 Macro Chapter 6 equip students with the knowledge and analytical skills to address real-world economic challenges in an open global market scenario.