Open Economy Macroeconomics (Class 12 Economics)

Practise chapter-wise MCQs for Class 12 Economics — Open Economy Macroeconomics. Every question comes with the correct answer and an explanation.

Open Economy Macroeconomics (Class 12 Economics)

Practise chapter-wise MCQs for Class 12 Economics — Open Economy Macroeconomics. Every question comes with the correct answer and an explanation.

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TL;DR: Practise chapter-wise MCQs for Class 12 Economics — Open Economy Macroeconomics. Every question comes with the correct answer and an explanation.

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Practise chapter-wise MCQs for Class 12 Economics — Open Economy Macroeconomics. Every question comes with the correct answer and an explanation.

Open Economy Macroeconomics MCQs with Answers & Explanations

Q1. Which of the following scenarios would likely lead to a decrease in foreign exchange reserves?

  1. An increase in the country's exports.
  2. A central bank intervention to prevent its currency from depreciating. ✓ (correct)
  3. A rise in foreign borrowing by domestic firms.
  4. A large inflow of foreign direct investment (FDI).

Explanation: If a country's currency is depreciating, the central bank might sell its foreign exchange reserves to buy its own currency, thereby supporting its value and decreasing its reserves.

Q2. Which of the following is NOT a component of the Balance of Payments?

  1. Financial Account
  2. Capital Account
  3. Invisible Trade Account ✓ (correct)
  4. Current Account

Explanation: The Balance of Payments is broadly divided into the Current Account and the Capital Account (which includes the Financial Account). Invisible Trade is a component of the Current Account, not a separate major account.

Q3. When a country has a deficit in its capital account, it implies:

  1. The country's currency has appreciated significantly.
  2. More capital is flowing into the country than flowing out.
  3. The country is exporting more goods than importing.
  4. More capital is flowing out of the country than flowing in. ✓ (correct)

Explanation: A capital account deficit means that the net outflow of capital from the country is greater than the net inflow. This includes investments made by residents abroad exceeding foreign investments made by non-residents in the country.

Q4. Managed floating exchange rate system is also known as:

  1. Dirty float ✓ (correct)
  2. Free float
  3. Gold standard
  4. Fixed exchange rate

Explanation: A managed float, or 'dirty float', is a system where the exchange rate is largely determined by market forces, but the central bank intervenes occasionally to influence the rate and maintain stability.

Q5. A country experiences a surplus in its Current Account. This generally implies:

  1. It is facing a shortage of foreign exchange.
  2. It is exporting more goods and services than it is importing. ✓ (correct)
  3. It is importing more goods and services than it is exporting.
  4. It is receiving more foreign investment than it is making abroad.

Explanation: A current account surplus means that the value of a country's exports of goods and services, along with net income and net current transfers, exceeds the value of its imports. This indicates that the country is earning more from its foreign transactions than it is spending.

Q6. Appreciation of a country's currency means:

  1. The country's exports become cheaper for foreigners.
  2. The country's imports become cheaper for domestic consumers.
  3. Its currency can buy more units of foreign currency. ✓ (correct)
  4. Its currency can buy fewer units of foreign currency.

Explanation: Appreciation means the domestic currency becomes stronger relative to foreign currencies, so more foreign currency can be bought with the same amount of domestic currency. This makes imports cheaper and exports more expensive.

Q7. The 'twin deficits' hypothesis suggests a relationship between:

  1. Interest rates and money supply.
  2. Inflation and unemployment.
  3. Capital account surplus and trade surplus.
  4. Current account deficit and budget deficit. ✓ (correct)

Explanation: The twin deficits hypothesis posits that a country's budget deficit and current account deficit are often related, with a larger budget deficit potentially leading to a larger current account deficit.

Q8. Under a flexible exchange rate system, a decrease in aggregate demand in the domestic economy would likely lead to:

  1. Depreciation of the domestic currency. ✓ (correct)
  2. No change in the exchange rate.
  3. Appreciation of the domestic currency.
  4. Increased foreign exchange reserves.

Explanation: A decrease in aggregate demand can lead to lower interest rates or a reduction in income, making domestic assets less attractive to foreigners and reducing demand for domestic goods, thus causing the currency to depreciate.

Q9. Which of the following is a measure to correct a deficit in the Balance of Payments?

  1. Devaluation of the domestic currency.
  2. Imposing import restrictions.
  3. Attracting foreign investment.
  4. All of the above. ✓ (correct)

Explanation: Devaluation makes exports cheaper and imports costlier, helping to reduce a deficit. Import restrictions directly reduce imports. Attracting foreign investment helps improve the capital account. Therefore, all options are measures to correct a BOP deficit.

Q10. If the nominal exchange rate between the Indian Rupee (INR) and the US Dollar (USD) is INR 70 = 1 USD, and India's inflation rate is 5% while the US inflation rate is 2%, what is the approximate expected real exchange rate after one year, assuming purchasing power parity (PPP)?

  1. INR 70.00 = 1 USD
  2. INR 72.10 = 1 USD ✓ (correct)
  3. INR 73.50 = 1 USD
  4. INR 68.00 = 1 USD

Explanation: According to PPP, the exchange rate should adjust to offset inflation differentials. The INR is expected to depreciate against the USD by the difference in inflation rates (5% - 2% = 3%). So, the new nominal exchange rate will be approximately 70 * (1 + 0.03) = 72.10 INR = 1 USD.

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