Keeping other factors constant, if the price of crude oil falls in the international market, it may lead to __

Question 38 of 77

Q. Keeping other factors constant, if the price of crude oil falls in the international market, it may lead to __________. (Choose the correct alternative to fill up the blank) (A) increase in trade deficit (B) decrease in trade deficit (C) no change in trade deficit (D) no change in the foreign exchange reserves

Bihar BsebCBSE Class XII Board 2023MCQ· 1mImportance★★★★★

49% · 38/77 Questions

🔒 Locked · start free trial →

You're viewing a preview — the full solution, concept, methods & PYQ mapping are locked.

Start your 14-day free trial to unlock the full solution →

Concept understanding — Current Account Deficit

The Current Account Deficit: Spending More Than You Earn, But With a Country

Think of your monthly allowance. If you spend ₹2,000 but only earn ₹1,500, you have a deficit of ₹500. You cover that gap by borrowing from a friend or dipping into savings. A country does the same thing on a massive scale — that's the Current Account Deficit (CAD).

The Everyday Intuition

A country's current account is like its income-and-expenditure diary with the rest of the world. It records three main things:

Goods (exports and imports of physical items — phones, wheat, oil)
Services (IT exports, tourism, shipping)
Transfers (money sent home by workers abroad, foreign aid)

When the total money flowing out for imports, services, and transfers exceeds the money flowing in from exports, services, and transfers, you have a deficit. The country is a net borrower from the world.

Note

A deficit is not automatically "bad." It means the country is consuming or investing more than it produces — which can be fine if the borrowed money goes into productive assets (factories, roads) that generate future income.

The Precise Definition (NCERT Style)

The current account is part of the Balance of Payments (BoP) — the record of all economic transactions between residents of a country and the rest of the world.

\text{Current Account Balance} = (X - M) + (X_{\text{services}} - M_{\text{services}}) + \text{Net Transfers} + \text{Net Income}

Where:

$X$ = Exports of goods
$M$ = Imports of goods
$X_{\text{services}}$ = Exports of services (e.g., Indian IT firms selling software to the US)
$M_{\text{services}}$ = Imports of services (e.g., Indians using Netflix)
Net Transfers = Money received from abroad minus money sent abroad (e.g., remittances from Indians working in the Gulf)
Net Income = Earnings from investments abroad minus payments to foreign investors (e.g., dividends paid to a Japanese company that owns a factory in India)

If this total is negative, the country has a Current Account Deficit.

Why It Matters (The "So What?")

A CAD must be financed. How? By borrowing from abroad or selling assets to foreigners. This shows up on the other side of the BoP — the Capital Account. If a country runs a CAD of $50 billion, it must attract$ 50 billion of foreign investment (FDI, FII, loans) to balance the books.

Three things to watch:

Sustainability — A small CAD (say 2-3% of GDP) is normal for a growing economy like India. A large, persistent CAD (5%+ of GDP) signals trouble: the country is living beyond its means and may struggle to repay.
Currency pressure — To finance a CAD, the country needs foreign currency (dollars). High demand for dollars can weaken the rupee. A weaker rupee makes imports costlier (inflation) but helps exports.
The J-Curve effect — When the rupee depreciates, the trade deficit often worsens initially before improving. Why? Imports are priced in dollars and become more expensive in rupees immediately, while export volumes take time to respond. The graph of the trade balance over time looks like a "J" — dipping first, then rising. …

Start your 14-day free trial to unlock the full solution →

A fall in international crude oil prices reduces the cost of India's major import, leading to a decrease in the value of imports and consequently a decrease in the trade deficit.

To understand the impact of a fall in crude oil prices on the trade deficit, we first need to define what a trade deficit is and how it is calculated. The trade deficit, also known as the balance of trade deficit, occurs when the value of a country's imports of goods and services exceeds the value of its exports of goods and services over a specific period.

\text{Trade Deficit} = \text{Value of Imports} - \text{Value of Exports}

India is a significant net importer of crude oil. A substantial portion of its foreign exchange earnings is used to pay for crude oil imports, which are essential for its energy needs and economic activities. Therefore, the price of crude oil in the international market has a direct and considerable impact on India's import bill.

When the price of crude oil falls in the international market, and assuming the quantity of crude oil imported remains constant (as per the "keeping other factors constant" condition), the total value of crude oil imports will decrease. This is because the country needs to spend less foreign exchange to purchase the same amount of oil.

Note

The "keeping other factors constant" clause is crucial here. It implies that the volume of oil imported does not change significantly due to the price fall, nor do other exports or imports change in value. This allows us to isolate the effect of the crude oil price change. …

Start your 14-day free trial to unlock the full solution →

←Previous questionQ18 — “There exists a positive relation between foreign exchange rate and su…→Next questionQ20 — Read the following statements carefully : Statement 1 : Import of gold…

🎓Unlock everything free for 14 days

Unlock everything free for 14 days