Why are foreign exchange rate and demand for foreign exchange inversely related? Explain.
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When foreign exchange rate rises, imports become costly for the domestic consumers. This reduces demand for imports causing fall in demands for foreign exchange (When foreign exchange rate falls, opposite happens. Import become cheaper and in turn raising demand for foreign exchange).
(Explanation based on anyone rise or fall in foreign exchange rate, is sufficient to attract full credit.)
Detailed Answer:
When price of a foreign currency falls, its demand rises, owing to the following reasons:
(i) Indian players in the international market will now buy more of foreign currency/ because now it is available at a lower price. Thus, the demand rises.
(ii) Now, imports become cheaper than before. Accordingly, imports tend to rise implying a rise in the demand for foreign currency.
(iii) Travelling abroad now becomes cheaper. Accordingly, demand for the foreign currency rises.
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