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Open-Economy Macroeconomics NCERT Textbook With Solutions Book PDF Free Download
Chapter 6: Open Economy Macroeconomics
An open economy is one that interacts with other countries through various channels. So far we had not considered this aspect and are just limited to a closed economy in which there are no linkages with the rest of the world in order to simplify our analysis and explain the basic macroeconomic mechanisms.
In reality, most modern economies are open. There are three ways in which these linkages are established.
- Output Market: An economy can trade in goods and services with other countries. This widens choice in the sense that consumers and producers can choose between domestic and foreign goods.
- Financial Market: Most often an economy can buy financial assets from other countries. This gives investors the opportunity to choose between domestic and foreign assets.
- Labour Market: Firms can choose where to locate production and workers to choose where to work. There are various immigration laws that restrict the movement of labor between countries. The movement of goods has traditionally been seen as a substitute for the movement of labor.
- We focus on the first two linkages. Thus, an open economy is said to be one that trades with other nations in goods and services and most often, also in financial assets. Indians for instance,
can consume products that are produced around the world and some of the products from India are exported to other countries. - Foreign trade, therefore, influences Indian aggregate demand in two ways. First, when Indians buy foreign goods, this spending escapes as a leakage from the circular flow of income decreasing aggregate demand. Second, our exports to foreigners enter as an injection into the circular flow, increasing aggregate demand for goods produced within the domestic economy.
When goods move across national borders, money must be used for the transactions. At the international level there is no single currency that is issued by a single bank.
Foreign economic agents will accept a national currency only if they are convinced that the number of goods they can buy with a certain amount of that currency will not change frequently.
In other words, the currency will maintain a stable purchasing power. Without this confidence, a currency will not be used as an international medium of exchange and unit of account since there is no
international authority with the power to force the use of a particular currency in international transactions.
In the past, governments have tried to gain the confidence of potential users by announcing that the national currency will be freely convertible at a fixed price into another asset.
Also, the issuing authority will have no control over the value of that asset into which the currency can be converted. This other asset most often has been gold or other national
currencies.
There are two aspects of this commitment that has affected its credibility — the ability to convert freely in unlimited amounts and the price at which this conversion takes place.
The international monetary system has been set up to handle these issues and ensure stability in international transactions.
With the increase in the volume of transactions, gold ceased to be the asset into which national currencies could be converted (See Box 6.2).
Although some national currencies have international acceptability, what is important in transactions between two countries is the currency in which the trade occurs.
For instance, if an Indian wants to buy a good made in America, she would need dollars to complete the transaction. If the price of the good is ten dollars, she would need to know how much it would cost her in Indian rupees.
That is, she will need to know the price of dollars in terms of rupees. The price of one currency in terms of another currency is known as the foreign exchange rate or simply the exchange rate.
| Author | NCERT |
| Language | English |
| No. of Pages | 20 |
| PDF Size | 2 MB |
| Category | Economics |
| Source/Credits | ncert.nic.in |
NCERT Solutions Class 12 Economics Chapter 6 Open Economy Macroeconomics
1. Differentiate between the balance of trade and current account balance.
| Basis of Comparison | Balance of trade | Current account balance |
| Definition | The difference between the import and export of all goods | The difference between the import and export of goods as well as services |
| Transaction type | Transactions of visible items i.e. goods takes place | Transactions of visible items (goods) and invisible items (services) takes place |
| Scope | It is a narrow concept and forms a part of current account balance | It is a wider concept that comprises of balance of trade |
2. What are official reserve transactions? Explain their importance in the balance of payments.
Transactions that are carried out by the monetary authority of a country that makes changes in official reserves is known as official reserve transaction or ORT. Transactions such as purchase and sale of currency in exchange market for other assets and foreign currencies.
By selling foreign currencies in the exchange market during periods of deficit and purchasing them during surplus periods. The increase and decrease in the official reserve are called as the balance of payments surplus and deficit respectively.
The importance of Official reserve transactions in the balance of payments are:
1. Helps in adjusting deficit or surplus in balance of payments
2. Purchasing of own currency is regarded credit item in the balance of payments whereas selling is regarded as a debit.
3. Explain the automatic mechanism by which BoP equilibrium was achieved under the gold standard.
In the Gold standard system, gold is considered a common unit to measure another nation’s currency or in other words value of a currency was defined in terms of gold.
The exchange rates was fixed in upper and lower limits and it was allowed to fluctuate within those limits.
Therefore exchange rates became stable under the gold standard and due to this reason all countries maintained their individual stock of gold which was used for currency exchange.
NCERT Class 12 Economics Textbook Chapter 6 Open Economy Macroeconomics With Answer PDF Free Download