question_answer

When price of a foreign currency rises, its demand falls. Explain why.

Or

When price of a foreign currency rises, its supply also rises. Explain why.

Answer:

When the price of foreign currency rises then it implies that foreign goods have become expensive for the domestic residents of the country. This results in a fall in the demand for foreign goods by the domestic residents. Consequently, the demand for foreign currency falls.

For example, suppose the rupee-dollar exchange rate (price of dollars in terms of rupees) rises from say, from\[\$1=Rs.\text{}68\,\,\,\,to\,\,\,\,\$1=Rs.\text{}70\]. This implies that in order to purchase one dollar worth of foreign goods, the domestic residents now have to pay Rs. 70 instead of Rs. 68. Thereby, the demand for foreign goods decreases. Consequently, the demand for dollars decreases.

Or

When the price of foreign currency rises, this implies that the domestic goods have become cheaper for the foreign residents. This is because they can now buy more goods and services with same worth of foreign currency. As a result, the foreign demand for domestic products rises. This leads to an increase in the exports of domestic country. As a result, the domestic country receives more foreign currency and its supply rises.

For example, suppose the rupee-dollar exchange rate (price of dollars in terms of rupees) rises from say, from\[\$1=Rs.\text{}68\,\,\,\,to\,\,\,\,\$1=Rs.\text{}70\]. This implies that the foreign residents can now buy Rs 70 worth of goods with the same one dollar. Thus, the demand for domestic goods increases. As a result, the supply of dollars increases.