Balance of Payments — Part 2: Exchange Rates: visual lesson, CBSE Class 12 Economics

Lesson

Exchange rates

Part 2 — the exchange rate, the three systems, and how demand and supply set the rate.

In this lesson you will

Explain the foreign exchange rate and read changes in it
Compare fixed, flexible and managed floating exchange rate systems
Distinguish devaluation from depreciation, and revaluation from appreciation
Explain how demand and supply determine the exchange rate in a free market, and the effect of shifts

Part 2 at a glance

Concept

The exchange rate is the price of one unit of foreign currency in terms of domestic currency, e.g. rupees per US dollar.

Imagined quotes, not current market rates.
Quote	Meaning
₹82 per US dollar	One dollar costs 82 rupees
Rate rises to ₹85	Dollar dearer; rupee worth less (depreciates)
Rate falls to ₹80	Dollar cheaper; rupee worth more (appreciates)

Concept

Table of the three exchange rate systems: fixed, set by the government; flexible, set by demand and supply; managed floating, set by the market with central bank intervention
System	Who sets the rate	Changes in value called
Fixed (pegged)	Government or central bank	Devaluation / revaluation
Flexible (floating)	Demand and supply in the market	Depreciation / appreciation
Managed floating	Market, with central bank intervention	Depreciation / appreciation