question_answer

                    

(i) How is fixed rate of exchange determined?

(ii) Explain the main merits of flexible exchange rate.

Answer:

            (i) Fixed rate of exchange is not determined by the forces of demand and supply in the market. It is fixed or     declared officially by the country's concerned authority. Such a rate of exchange has been associated with standard system during 1880-1914. According to this system, value of every currency is determined in terms of gold.                                      Accordingly, the ratio between gold value of the two currencies was fixed as exchange rate between those currencies.                                                                                  For example,                                                                                     Value of one dollar = 20 g of gold; Value of a rupee = 5 g of gold                                        Then, 1$=\[\frac{20}{4}\] =Rs.4                                                    (ii) The main merits of flexible exchange rate are as follows:                                                [a] It eliminates problems of over-valuation and under-valuation of currencies as it is self- adjusting and   automatically removes the disequilibrium in the Balance of Payments (BoP).                         [b] It enhances the movement of capital across different parts of the world and promotes international growth. [c] It enhances the opportunity for optimum utilisation of resources and raises the level of efficiency in the economy.