Question

Discuss what information a country must consider when deciding to peg the exchange rate. Real-world examples are encouraged. Use of chapter vocabulary is expected.

Answer 1

There are few things a country must consider when deciding to peg the exchange rate.Let us take an example, there are two countries – India and U.K. and the exchange rate of their , rupee and pound is to be determined.
Presently, there is floating or flexible exchange regin in both India and U.K. Therefore, the worth of currency of each country in terms of the other currency confides in the demand for and supply of their currencies.
Diagram :-

In the diagram, the demand curve is decending sloping. This means that little foreign exchange is demanded as the exchange rate rises. This is due to the fact that the increase in price of foreign exchange enhances the rupee cost of foreign goods, which make them more costly. As a result, imports lessen. Thus, the demand for foreign exchange also lessen.
The supply curve is rising
sloping which means that supply of foreign exchange rises as the exchange rate increases. This makes home country’s goods become low cost to foreigners since rupee is devaluation in value. The demand for our exports should therefore rises as the exchange rate enhances. The enlarged demand for our exports converts into greater supply of foreign exchange. So, the supply of foreign exchange grows as the exchange rate increases.