question_answer

When price of a foreign currency falls, the demand for that foreign currency rises. Explain why.

Or

When price of a foreign currency falls, the supply of that foreign currency also falls. Explain? Why?

Answer:

When the price of foreign currency falls then it implies that foreign goods have become cheaper for the domestic residents of a country. As a result, the demand for the foreign goods by the domestic residents rises, which rises the demand for foreign currency as well.

For example, suppose the rupee-dollar exchange rate (price or dollars in terms of rupees) falls from say, from\[\$1=Rs.\text{}50\,\,\,\,to\,\,\,\,\$1=Rs.\text{}48\]. This implies that in order to purchase one dollar worth of goods domestic residents now have to pay Rs. 48 instead of Rs. 50. As a result, demand for the foreign goods increases and the demand for dollars also rises.

Or

When the price of foreign currency falls, then this implies that the domestic goods have become expensive for the foreign residents. This is because they can now buy less goods and services with the same worth of the foreign currency. As a result, the foreign demand for the domestic products falls. This leads to a fall in the exports of the native country. With fall in the exports, the native country receives less foreign currency, thereby, reduces the supply of foreign currency in the economy.

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