vu cs403 Mid Term Subjective Solved Past Paper No.3

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Fixed exchange rate

A fixed exchange rate means the amount of currency received is set in advance.

A fixed exchange rate is based upon the government's view of the value of its currency as well as the monetary policy. It has advantages. Stability is one. Another is predictability. Businesses and individuals can plan their activities with the certainty of the value of money. A businessman shipping goods overseas knows the value in advance. A tourist travelling in other countries can budget knowing what his money will buy.

Floating exchange rates

A floating exchange rate means that the rate is moving and the currency received depends on the time of the exchange

The floating exchange rate, in its true form, allows the marketplace to set the rate. The forces of supply and demand determine the value of a currency.

For example, when the US dollar is considered strong it will take more euros, the currency of most European countries, to buy. When the US dollar is considered weak or in decline the amount of euros needed to buy it will fall.

Inflation is a situation in which there is a continuous rise in the general price level.

WHEREAS Deflation is the opposite of inflation and occurs when the general level of prices falls.

Inflation is when the money supply increases by more than the real economy does. This means that one unit of currency will buy less than it could in the past.

Deflation is when the money supply contracts, making a unit of currency able to buy more than it could in the past. This is the exact opposite of inflation, but it is also bad.

By international trade, we mean the exchange of goods and services between different countries.

International trade is the trade between two or more different countries. It is just the opposite of the trade that takes place within a country i.e. national trade.

Whereas International finance is concerned with, among other thing, the mobility of financial capital across countries, and the problems and opportunities this mobility presents indi-vidual countries with. It would not be too inaccurate (in present day context) to say that while international trade deals with the current account, international finance deals with the capital account of the BOPs. That said, issues like the choice of exchange rate regime and of modern-day balance of payments crises also fall firmly within the purview of international finance.

Risk and Uncertainty

Risk is when an outcome may or may not occur but its probability is known while uncertainty is when an outcome may or may not occur but its probability is not known.

IMF's Stabilization Theories

Tight Fiscal Policy

It works through higher revenues and reduced government expenditure.

Devaluation

Switching from imports to home produced goods. It increases competitiveness, exports and increase investors confidence in local currency.

Tight Monetary Policy

Higher interest rates resulting in reduced private sector consumption and investment demand. It reduces inflation and increases savings. High interest rates also results in higher capital inflow.

Theses theories are generally not successful in lower income countries (LICs).
Because they caused the problems of:

Devaluation

It raises the price of imports and also increased the inflation while the real wage rate could not increase.

Stabilization hurts poor

It decrease in expenditure always badly effects the poor which can then cause political instability

Following are the components on the assets and liabilities side of the balance sheet of a central bank

ASSET SIDE COMPONENTS:

1. Loans to Govt Notes
2. Forex reserves
3. Loans to private sector

LIABILITY SIDE COMPONENTS:

1. Notes, coins & currency in circulation
2. Govt & commercial bank deposits
3. Liquidity paper issued

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In economics, endogenous growth theory or new growth theory was developed in the 1980s as a response to criticism of the neo-classical growth model.

In neoclassical growth models, the long-run rate of growth is exogenously determined by assuming a savings rate (the Solow model) or a rate of technical progress. This does not explain the origin of growth, which makes the neo-classical model appear very unrealistic. Endogenous growth theorists see this as an over-simplification Following table shows different stages of production of cloth. Calculate the value added at each stage of production. What is GDP by this approach?

The Exogenous growth model, also known as the Neo-classical growth model or Solow growth model is a term used to sum up the contributions of various authors to a model of long-run economic growth within the framework of neoclassical economics