Question

Arrange the following statements depicting the impact of an increase in demand for imports on the foreign exchange market.
(A) Demand for foreign goods and services increases.
(B) Shift in demand curve towards right.
(C) Depreciation of domestic currency in terms of foreign currency.
(D) Increase in exchange rate.
Choose the correct answer from the options given below:

• A. (A), (B), (C), (D)
• B. (A), (B), (D), (C)
• C. (B), (A), (D), (C)
• D. (C), (B), (D), (A)

Hint:

Always follow the chain of causation:
Preference shift $\rightarrow$ Import demand rises $\rightarrow$ Foreign currency demand curve shifts right $\rightarrow$ Exchange rate ($e$) rises $\rightarrow$ Domestic currency depreciates.

Answer 1

The Correct Option is B

Concept:
In a flexible exchange rate regime, the exchange rate is determined by the intersection of the market demand and supply curves for foreign exchange.
Any autonomous macroeconomic event that alters domestic preferences toward foreign goods sets off a sequential chain of adjustments in the foreign currency market.

Step 1: Sequential Analysis of the Market Adjustment:
The process originates with an autonomous shift in domestic consumer preferences or requirements, leading to an increase in the demand for foreign goods and services (A).
Because residents require foreign currency to settle payments for imported goods and services, the demand for foreign currency rises at any given exchange rate.
This shift leads to an outward or rightward shift in the demand curve for foreign exchange (B).
With the foreign exchange supply curve held constant, this rightward shift induces an excess demand for foreign exchange at the existing exchange rate.
Competition among domestic buyers drives up the price of foreign exchange, which means there is an increase in the exchange rate (D).
An increase in the exchange rate defined as domestic currency per unit of foreign currency means the home currency loses purchasing value relative to foreign currency, denoting depreciation of domestic currency (C).

Step 2: Establishing the Chronological Order:
The causal economic progression unfolds precisely as:
First: Demand for foreign goods and services increases (A).
Second: Shift in the demand curve of foreign currency towards the right (B).
Third: Increase in the equilibrium foreign exchange rate (D).
Fourth: Consequent depreciation of the domestic currency in terms of foreign currency (C).
This exact chronological progression is captured by (A), (B), (D), (C).
Final Answer:
Therefore, the correct chronological sequence is represented by Option (B).