Question
How is the exchange rate determined under a flexible exchange rate regime?
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Answer
Flexible exchange rate is determined by the forces of supply and demand in the international market. And the equilibrium exchange rate is determined at a level where demand for foreign exchange is equal to the supply of foreign exchange. 
In the figure, the equilibrium exchange rate i.e., E.
Sources of demand for foreign exchange:
- Payment of international loans.
- Gifts and grants to rest of the world.
Source of supply of foreign exchange:
- Export to the rest of the world.
- Direct foreign investment.
- Direct purchase of goods and services by the non-residents in the domestic market.
In the figure, the equilibrium exchange rate i.e., E.Need a full question paper?
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