Economics/Macroeconomics

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Question
How is the Rupee-dollar exchange rate determined?How does a depreciation of the Indian Rupee affect oil prices?

Answer
Hi,

THE FIRST PART OF YOUR QUESTION
Indian rupee-dollar exchange rate is determined by the demand for and supply of commodities traded in the international market.

If the demand for Indian goods increases, foreigners have to pay more in Indian currency. That means the importing nations have to buy Indian currency in the foreign-exchange market. As the demand for Indian currency in turn goes up, the exchange ratio of Indian rupee to dollar goes up. That means the demand curve showing the demand for Indian currency as a function of dollar [measured in a positive quadrant of rupee,dollar plane]shifts to the right, and the exchange rate (measured up the vertical axis) goes up. On the other hand, the Indian demand for foreign commodities falls, there is a decrease in the foreign-exchange market of India's demand for dollars. This leads to a downward shift of the demand curve, and the exchange rate falls.

This is also related to the supply of exportable commodities. When production rises, triggering an increase in supply, the upward-sloping supply curve on a quantity,price plane shifts to the right, causing a fall in price of such commodity. This leads to a fall in the foreign-exchange ratio, by which Indian rupee depreciates. It may also be mentioned that, when the currency of a country depreciates, its exports increases. Conversely, when there is appreciation, exports falls. By the same token, invoking a reverse logic, we can say, as production of exportable commodities increases and hence as export increases, exchange rate falls, and vice versa.

THE SECOND PART OF YOUR QUESTION
The depreciation of Indian rupee will make imported commodities dearer. This so because the Indians have to pay in Indian rupees, and they have now to pay a larger sum of Indian rupees for the sum of pre-depreciation amount of dollars. Imported oil prices will go up. This will also exert a derived effect on India-produced oil. Even if depreciation is not supposed to impact domestic prices, home-produced oil may register a derived increase in price of oil domestically produced.

One thing should be borne in mind clearly. The international oil prices are less likely to be affected by depreciation of Indian currency. The OPEC market is basically influenced by international demand, and Indian demand for oil forms only a fraction of the total world demand for oil.

I hope this serves your purpose. I have tried to explain these matters as simply as possible, without the use of financial math, such as elasticities and foreign-exchange multiplier, etc. Best of luck in your pursuit.

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Eklimur Raza

Expertise

It appears some students in this website are confused about elasticity of demand and the slope of the demand curve when they are trying to figure out why rectangular hyperbola comes up in case of unitary demand curve. First, they don't know that RH can be depicted in a positive quadrant of price,quantity plane. Secondly, they make the mistake that the slope of RH is constant at -1. Two points could help them: first, e=1 at each and every point of the RH, because the tangent at any point shows lower segment=upper segment (another geometric definition of e); yet slopes at different points,dQ/dP, are different; second, e is not slope but [(Slope)(P/Q)]in absolute terms. Caveat: only if we measure (log P) along the horizontal axis and (log Q) up the vertical axis, can we then say slope equals elasticity --in which case RH on P,Q plane is transformed into a straight-line demand curve [with slope= -tan 45 deg] on (log Q),(logP) plane, and e= -d(log Q)/d(log P). [By the way, logs are not used in college textbooks --although that is helpful in econometric estimation of elasticity viewed as an exponent of P, when demand equation is transformed into log-linear form.] I have not found the geometrical explanation I have given in any textbook followed in undergraduate and college classes in Canada (including the book followed in a university where I taught for a short time and in the book followed in George Brown College, Toronto, where I teach.

Experience

About 11 years' teaching economics and business studies, and also English, history and elementary French.Practical experience in a development bank, working with international donor agencies like the World Bank and the ADB. Experience in free-lance journalism, including Canada's "National Post."

Organizations
I teach micro- and macroeconomics at George Brown College (continuing education), Toronto, ON, Canada.

Publications
Many articles and editorials, on different subjects, in English newspapers. Recently an applied Major Research Paper, based on a synthesis of the Solow growth model and the Lewis two-sector model, has be accepted by Ryerson University, Toronto. Professors Thomas Barbiero and Eric Cam, Ryerson University, accepted the paper.

Education/Credentials
Master degree in Interantional Economics and Finance and diploma with honours in Business Administration from Canada.

Awards and Honors
Received First Prize in an inter-university Literary Contest.

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