Chapter – 5

Balance of Payments

In this post, we have given the Important Questions of Class 12 Economics Chapter 5 (Balance of Payments) in English. These Important Questions are useful for the students who are going to appear in class 12 board exams.

Board	CBSE Board, UP Board, JAC Board, Bihar Board, HBSE Board, UBSE Board, PSEB Board, RBSE Board
Textbook	NCERT
Class	Class 12
Subject	Economics
Chapter no.	Chapter 5
Chapter Name	(Balance of Payments)
Category	Class 12 Economics Important Questions in English
Medium	English

Chapter 5 Balance of Payment

VERY SHORT ANSWER TYPE QUESTIONS

Q.1Give the meaning of managed floating exchange rate.

Ans. The system of adjusting the exchange rates as per the rules and regulations of foreign exchange market is termed as managed floating.

Q.2 Define foreign exchange rate.

Ans. Foreign exchange rate refers to the rate at which one currency can be exchanged for the other currency in foreign exchange market, e.g. if Rs. 58 is paid to buy one US dollar, then Rs./$ exchange rate will be 58 i.e. Rs.58 per dollar.

Q.3 What is floating exchange rate?

OR

Define flexible exchange rate system.

Ans. The rate of exchange which is determined by the market forces of demand and supply of foreign currencies in the foreign exchange market, is termed as flexible exchange rate system

Q.4 What is a fixed exchange rate?

Or

Give the meaning of fixed foreign exchange rate.

Ans. Fixed exchange rate is the system under which the central authority or government maintains their exchange rate fixed either against gold or some other foreign currency, (say USD)

Q.5. What is foreign exchange?

Or

Give meaning of foreign exchange.

Ans.Foreign exchange refers to the reserve of foreign currency with a country, e.g. currency of US and UK are the foreign exchanges for India.

Q.6. State two sources of supply of foreign exchange.

Ans. Two sources of supply of foreign exchange are:

(i) Export of goods and services from domestic country to foreign country.

(ii) Foreign direct investment.

Q.7. State two sources of demand for foreign exchange.

Ans. Two sources of demand for foreign exchange are

(i) Payment of loans and interest to international organizations.

(ii) Gifts and grants to rest of the world.

Q.8. What is meant by appreciation of currencies?

Ans. Appreciation of a currency occurs when its exchange value in relation to currencies of other country increases.

Q.9. Define Spot exchange rate.

Ans.The spot exchange rate refers to the rate at which foreign currencies are available on the sport.

Q.10. Define forward market.

Ans. Market for foreign exchange for future delivery is known as the forward market.

Q.11 What is meant by balance of payments?

Ans. Balance of payments refers to the statement of accounts recording all economic transactions of a given country with the rest of the world.

Q.12 What do you mean by balance of trade?

Ans. Balance of trade is the difference between the value of imports and exports of only physical goods.

Q.13 The balance of trade shows a deficit of Rs. 600 crores, the value of exports is Rs.1000 crores. What is value of Imports?

Ans. Balance of Trade = Exports of goods – import of goods Import of good = Export of goods – (B.O.T) = 1000- (-600) = Rs. 1600.

Q.14 What is the balance of visible items in the balance of payments account called?

Ans. Balance of trade

Q.15 What do you mean by disequilibrium in BOP?

Ans. Disequilibrium in BOP is means either there is a surplus or deficit in balance of payment account.

Q.16. List two items of the capital account of BOP account.

Ans.

• external assistance
• commercial borrowing
• foreign investment

Q.17 Which transactions bring balance in the BOP account?

Ans. Accommodating transactions bring balance in the BOP account.

Q.18.Define autonomous items in BOP.

Ans. Autonomous items in BOP refer to international economic transaction that take place due to some economic motive such as profit maximization. These items are independent of the state of the country balance of payments.

Q.19.What is the other name of autonomous items in the BOP?

Ans. The other name of autonomous items in BOP is above the line item.

Q.20. When does a situation of deficit in BOP arises?

Ans. A situation of deficit in BOP arises when autonomous receipts are less than autonomous payments.

Q.21What is meant by managed floating?

Ans. It is a system that allows adjustments in exchange rate according to a set of rules and regulations which are officially declared in the foreign exchange market.

Q.22 What is meant by dirty floating?

Ans. Manipulate the exchange rate without following the guidelines issued by IMF is called dirty floating.

Q.23. What is “Current Account Deficit” in the balance of payments?

Ans. When foreign exchange receipts in the current account fall short of foreign exchange payments, it is called Current Account Deficit.

Q.24.What is excess of exports of goods over the imports of goods called ?

Ans. Surplus Balance of Trade.

SHORT TYPEANSWER QUESTIONS (3 / 4 MARKS)

Q.1.Why is foreign exchange demanded?

Ans. Foreign exchange is demanded for the following purposes.

• Payment of International loans
• Gifts and grants to rest of the world
• Investment in rest of the world.
• Direct purchases abroad for goods and services as well as imports from rest of the world.

Q.2 What determines the flow of foreign exchange in to the country?

Ans. Following factors contribute to the flow of foreign exchange in to the country.

• Purchases of domestic goods by the foreigners
• Direct foreign investment and portfolio investment in the home country.
• Speculative purchase of foreign exchange.
• When foreign tourists come to India.

Q.3. Why does the demand for foreign exchange rise, when it price falls?

Ans. With a fall in price of foreign exchange, the exchange value of domestic currency increases and that of foreign currency falls. This implies that foreign goods become cheaper and their domestic demand increases. The rising domestic demand for foreign goods implies higher demand for foreign exchange. So there is inverse relationship between price and demand for foreign exchange.

Q.4. When price of a foreign currency falls, the supply of that foreign currency also fall why?

Ans. When price of a foreign currency falls it makes exports, investment by foreign residents costlier as a result supply of foreign currency falls.

Q.5. Distinguish between autonomous and accommodating transaction of balance of payment account.

Ans. Autonomous transactions are done for some economic consideration such as profit, such transactions are independent of the state of B.O.P. Accommodating transactions are under taken to cover the deficit/surplus in balance of payments.

Q.6. Give two examples explain why there is a rise in demand for a foreign currency when its price falls.

Ans. When price of foreign currency falls, imports are cheaper. So, more demand for foreign exchange by importers. Tourism abroad is promoted as it becomes cheaper. So demand for foreign currency rises.

Q.7.Distinguish between fixed and flexible foreign exchange rate.

Ans. When foreign exchange rate is fixed by Central Bank/government, it is called fixed exchange rate. When foreign exchange rate is determined by market forces/mechanism, it is flexible exchange rate.

Q.8 Distinguish between devaluation and depreciation of domestic currency.

Ans. Difference between devaluation and depreciation

Devaluation

• Devaluation is the fall in the value of domestic currency in relation to foreign currency. It is planned by the Central Bank in situation, when exchange rate is not determined by the forces of demand and supply.
• A government has set 10 units of its currency is equal to one dollar.

Depreciation

• It occurs when the value of domestic currency decreases in relation to the value of foreign currency in the foreign exchange market
• If US $ exchanges ? 45 instead of ? 40 earlier the domestic currency (Indian rupee) has shown depreciation of domestic currency.

Q.9. Giving two examples, explain the relation between the rise in price of a foreign currency and its demand.

Ans.

• when the price of a foreign currency rises, the imports become costlier and exports become cheaper so the value of imports will fall with time, hence the demand for foreign exchange will fall.
• When domestic companies want to buy foreign assets and with the rise in price of foreign currency the price of the assets also increase. Hence, the demand for foreign exchange falls.

Q.10. How can increase in foreign direct investment affect the price of foreign exchange?

Ans. Increase in foreign direct investment will result in more supply of foreign exchange therefore, due to excess supply; price of foreign exchange will fall. I.e. exchange rate falls which leads to appreciation of domestic currency?

Q.11. When price of a foreign currency rises, its demand falls. Explain why?

Or

Why there is a fall in demand of foreign exchange, when its price rises. Explain.

Ans. Exchange rate of foreign currency is inversely related to the demand. When price of a foreign currency rises, it results into costlier imports for the country. As imports become costlier, the demand for foreign products also reduces. This leads to reduction in demand for that foreign currency and vice-versa.

Q.12. Explain the meaning and two merits of fixed foreign exchange rate.

Ans.Two merits of fixed foreign exchange rate are:

• Less speculation in the currency market.
• Encourages international trade and investment flows.

Q13. State two sources each of demand and supply of foreign exchange.

Ans.

Two sources of demand for foreign exchange are:

• Imports from rest of the world.
• Foreign investment across the world.

Two sources of supply of foreign currency are:

• Exports of goods and services from domestic country to foreign country.
• Remittances from abroad.

Q.14. Give the meaning of foreign exchange and foreign exchange rate. Giving reason, explain the relation between foreign exchange rate and demand for foreign exchange.

Ans. Foreign exchange Foreign exchange rate is determined by the market forces of demand and supply in foreign exchange market. The point where demand and supply of foreign exchange meet, gives the equilibrium rate of exchange as shown in figure and quantity of foreign exchange. Foreign exchange rate Foreign exchange rate refers to the rate at which one currency can be exchanged for the other currency in foreign exchange market, e.g. if Rs. 58 is paid to buy one US dollar, then Rs./$ exchange rate will be 58 i.e. Rs.58 per dollar.

Relation between foreign exchange rate and demand for foreign exchange There is an inverse relationship between the foreign exchange rate and demand for foreign exchange, with the rise in foreign exchange rate, demand for foreign exchange falls and vice versa.

Q.15. List the items included as invisibles in the Balance of Payments Account.

Ans. Invisible items are services such as:

• Transport services, insurance and banking services.
• Transfer such as gifts and donations.
• Income in form of wages, rent, interest and dividend.

Q.16. State the components of Capital Account of Balance of Payments.

Ans. Components :

• Borrowings and lending to and from abroad.
• Investment to and from abroad.
• Changes in foreign exchange reserves.

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