[Commerce Class Notes] on Open-Economy Macroeconomics and Exchange Rate Pdf for Exam

Macroeconomics has two kinds of economies. One is the open economy and the other is the closed economy. An open economy is an economy in which trading activity takes place between all the countries. That means it allows the buying and selling of goods and securities from the neighbouring countries. It is an international activity. Whereas the closed economy is an economy in which all the trading activities have taken place within the country. It doesn’t allow foreign trade and investments.

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Exchange Rate Quotations

The exchange rate is a rate which is known as the amount of currency which we can observe when it is converted into other currency. The difference between the two currencies for the same value of money is known as the exchange rate.

Exchange rate quotations are available in two different ways. One is a direct quotation, and the other is an indirect quotation. While discussing the exchange rates, we need to learn about the fixed currency and variable currency. Let’s take two countries, the one currency which we are going to express in terms of the other country’s currency. The first currency is the fixed currency, and the currency in which we are expressing is nothing but the variable currency because it may change from time to time.

Direct Quote and Indirect Quote

A direct quote is one way of quotation in which the single unit of foreign currency is expressed in terms of our currency which is the domestic country. Then it is known as a direct quote.

On the contrary, an indirect quote is another way of quotation in which the single unit of domestic currency has been expressed in terms of foreign currency, then it is called an indirect quote.

Illustration

If we take an Indian rupee as the domestic currency, then

Direct quote is

1 USD  = 74 INR (say)

And Indirect quote is,

1 INR = 188 Rp( Indonesian rupiah)

Components of the Exchange Rate – HE

The exchange rate has two different components. One is based currency, and the other one is the counter currency. These concepts are similar to the meaning of direct quotes and indirect quotes.

The foreign currency will act as a base currency, and the domestic currency is as the counter currency while using direct quotations. In contrast, the foreign currency is the counter currency, and the domestic currency is the base currency in the indirect quotation. Also, the Indirect rate in foreign exchange means the conversion rate will be expressed in terms of foreign currency for a single rupee of Indian currency If we take India as our domestic country. Similarly, the Direct quote currency is the currency of our domestic country because we express our currency in terms of foreign currency in this case.

As of now, we have learned the two kinds of foreign exchange quotations; we also need to understand various kinds of exchange rates because the direct quote and indirect quote are available for every kind of exchange rate. So, to implement the direct quotation and indirect quotation for every kind of exchange rate, we need to understand all the types of exchange rates.

Types of Exchange Rates

We have different kinds of exchange rate systems. Let us see the basic types of exchange rates.

The name itself explains that the exchange rate is fixed and prescribed by the government of that particular country. These mostly happen in dominant countries. USD is the best example of this. It is also known as the pegged exchange rate system.

It is quite the opposite to the above one. The exchange rate of which may not be constant and keep on changes based on the market conditions. Because it is decided based on the market conditions, several countries adopted these floating exchange rate systems.

Another type of exchange rate which can be specified the exact value at present. It means the value which can be mentioned at this particular point in time is nothing but a spot exchange rate. It may change from one day to another.

It majorly happens in trading activity. If the seller is restricted to sell his goods for months on a future date to get increased conversion value, these exchange rates are known as forwarded exchange rates. And the system using these rates is nothing but the forwarded exchange rate system.

The name itself specifies that it has dual values. It means that the same good or in bond May possess one value for international trade and the other value for domestic trade. Then these rating systems are known as a dual exchange rate system.

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Conclusion

Hence, we understood that the exchange rate is a rate of conversion that occurred from one currency to another currency. It is of two types in its notations. Both direct quotation and indirect quotation have their unique advantages along with few limitations.