Question

Read the following statements carefully:
Statement 1: Keeping other things constant, there exists positive correlation between the price of foreign exchange and its demand.
Statement 2: The foreign exchange rate indicates a country’s purchasing power in international markets.
In the light of the given statements, choose the correct option from the following:

• A. Statement 1 is true and Statement 2 is false.
• B. Statement 1 is false and Statement 2 is true.
• C. Both Statements 1 and 2 are true.
• D. Both Statements 1 and 2 are false.

Hint:

Remember: The demand curve for foreign exchange slopes downward due to the inverse relationship with its price. Also, exchange rates influence international trade and purchasing power.

Answer 1

The Correct Option is B

Analysis of Statement 1: Statement 1 is false. According to the law of demand, there exists an inverse relationship between the price of foreign exchange and its demand. That is, as the price (or exchange rate) of foreign currency increases, its demand generally falls, assuming other factors remain constant. For example, if the US Dollar becomes more expensive in terms of Indian Rupees, Indian consumers and importers will demand less of it. 
Analysis of Statement 2: Statement 2 is true. The foreign exchange rate reflects a country’s relative purchasing power in international markets. A stronger domestic currency (lower exchange rate per foreign unit) implies greater purchasing power abroad, while a weaker domestic currency means lower purchasing power. Therefore, the exchange rate serves as a signal of how much goods and services a nation can afford to buy from other countries.