Under the fixed exchange rate system, if the government decreases the value of domestic currency with respect

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Q. Under the fixed exchange rate system, if the government decreases the value of domestic currency with respect to a foreign currency, it is known as __________ of currency. (Choose the correct option to fill in the blank) Options : (A) Devaluation (B) Depreciation (C) Appreciation (D) Revaluation

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Concept understanding — Currency Devaluation Depreciation

Let’s start with something you already know. Suppose you have ₹100 and you want to buy a toy that costs $2. If the exchange rate is ₹50 =$ 1, you can buy exactly one toy. Now imagine the rate changes to ₹100 = $1. Your ₹100 now buys only$ 1 — you can no longer afford the toy. The rupee has become weaker relative to the dollar. That’s the everyday feeling of a currency losing value.

What is Currency Depreciation?

Depreciation is the fall in the value of one currency in terms of another currency under a flexible (floating) exchange rate system. In this system, the market — supply and demand for currencies — decides the rate. If more people want to sell rupees and buy dollars, the rupee’s price falls. That’s depreciation.

Example: If the rate moves from ₹70/ $to ₹80/$ , the rupee has depreciated. Each dollar now costs more rupees.

Note

Depreciation happens automatically in a floating rate system. It is not a government decision — it’s a market outcome.

What is Currency Devaluation?

Devaluation is the official reduction in the value of a currency by the government or central bank under a fixed exchange rate system. Here, the government pegs the currency to another currency (say, the dollar) and then deliberately lowers that peg.

Example: If the government had fixed ₹70/ $and then announces a new fixed rate of ₹80/$ , that’s devaluation.

Watch out

Many students mix these up. Remember: Depreciation = market-driven fall (floating rate). Devaluation = government-driven fall (fixed rate). The effect is similar — your currency buys less foreign currency — but the cause is different.

Why Does It Matter? The Real Effects

1. Exports become cheaper, imports become costlier

When the rupee depreciates (or is devalued), Indian goods become cheaper for foreigners. A shirt that costs ₹500 earlier cost $10 at ₹50/$ . Now at ₹100/ $, it costs only$ 5. Foreign buyers buy more — exports rise.

But the reverse is painful. An imported laptop that cost $1000 earlier cost ₹50,000. Now it costs ₹1,00,000. Imports become expensive, hurting consumers and industries that rely on foreign raw materials.

2. Impact on the trade balance

If exports rise and imports fall, the trade deficit (exports minus imports) may shrink. But this is not guaranteed — if demand for imports is inelastic (people must buy them anyway), the import bill actually rises in rupee terms.

3. Inflation pressure

Since imported oil, machinery, and components cost more, production costs rise. Firms pass this on to consumers. This is called imported inflation.

4. Debt burden

If India has borrowed in dollars, a weaker rupee means we need more rupees to repay the same dollar debt. This increases the burden on the government and companies.

The Formula (Yes, there is one — but it’s simple)

The NCERT textbook does not give a separate formula for depreciation/devaluation itself. But the concept is tied to the exchange rate:

\text{Exchange Rate} = \frac{\text{Price of domestic currency}}{\text{Price of foreign currency}}

More commonly, we write it as:

\text{₹ per $} = \frac{\text{₹}}{\text{$}}

If this number rises, the domestic currency (₹) has depreciated or been devalued.

There is also the percentage change formula:

\text{Percentage depreciation} = \frac{\text{New rate} - \text{Old rate}}{\text{Old rate}} \times 100

Example: Rate goes from ₹70/ $to ₹80/$ .

\frac{80 - 70}{70} \times 100 = 14.3\%

The rupee has depreciated by 14.3% against the dollar.

Tip

Always check which currency is in the denominator. If the denominator currency strengthens, the numerator currency weakens. A rising ₹/$ rate means the rupee is falling.

A Diagram in Words

Draw a standard supply-and-demand graph for dollars. On the vertical axis, put “₹ per $” (the exchange rate). On the horizontal axis, put “Quantity of$ ”. …

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Under a fixed exchange rate system, a deliberate reduction in the value of a domestic currency by the government is termed devaluation.

To understand the correct term, we first need to distinguish between the two primary types of exchange rate systems: fixed and flexible (or floating). The mechanism by which a currency's value changes depends critically on which system is in place.

Under a fixed exchange rate system, the government or the central bank officially sets and maintains the exchange rate at a specific level against a foreign currency or a basket of currencies. To maintain this fixed rate, the central bank must intervene in the foreign exchange market by buying or selling foreign currency. If market forces push the domestic currency's value down, the central bank sells foreign currency to buy domestic currency, increasing demand for the domestic currency and supporting its value. Conversely, if market forces push the domestic currency's value up, the central bank buys foreign currency by selling domestic currency, increasing the supply of domestic currency and preventing its appreciation.

When the government or central bank deliberately decides to decrease the official value of its domestic currency relative to a foreign currency under this fixed system, this action is known as devaluation. This is a policy decision, often undertaken to make exports cheaper and imports more expensive, thereby improving the trade balance.

Note

Devaluation is a policy tool used by governments to adjust their currency's value in a fixed exchange rate regime.

In contrast, under a flexible exchange rate system, the value of a currency is determined purely by the forces of demand and supply in the foreign exchange market, without direct intervention from the government or central bank.

If the value of the domestic currency falls due to market forces (e.g., increased supply of domestic currency or decreased demand for it), it is called depreciation.
If the value of the domestic currency rises due to market forces (e.g., decreased supply of domestic currency or increased demand for it), it is called appreciation.

Similarly, if the government or central bank deliberately decides to increase the official value of its domestic currency relative to a foreign currency under a fixed exchange rate system, this action is known as revaluation. …

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Q.Under the fixed exchange rate system, if the government decreases the value of domestic currency with respect to a foreign currency, it is known as __________ of currency. (Choose the correct option to fill in the blank) Options : (A) Devaluation (B) Depreciation (C) Appreciation (D) Revaluation

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