Economic development, Exchange rate

Economic development

It is a normative concept i.e. it applies in the context of people's sense of morality (good and bad, right and wrong). The definition of economic development given by Michael Todaro is an increase in living standards, improvement in self-esteem needs and freedom from oppression as well as a greater choice. The most accurate technique for measuring economic development is the Human Development Index (HDI) which takes into account the life expectancy as well as literacy rate which influences productivity and could lead to Economic Growth. Economic development also leads to the creation of various huge opportunities in the sectors of employment, healthcare, and the conservation of the environment. It implies a rise or increase in the per capita income of each and every citizen in the country.

Generally, economic growth does not measure the size of the informal economy of the country. The informal economy is also known as the black economy or illegal economy which is not recorded in the economic activity. Development improves people from low standards of living into better standard with proper employment and suitable shelter. Economic growth does not consider the reduction of natural resources that might direct to pollution, disease and congestion. However, economic development is concerned or dedicated with sustainability. It means gathering the requirements of the present without negotiating future requirements. These environmental effects are becoming more of a problem for governments now that the pressure has raised on them due to global warming.

Economic growth is a necessary but not sufficient condition of economic development.

Theory of rate of exchange (Demand – Supply Approach)

According to this theory, the exchange rate in a free exchange market is determined at a level where demand for foreign exchange is equal to the supply of exchange.

The main sources of supply of foreign exchange are:

1. The domestic exporters who receive payments of foreign currency.
2. The foreigners who invest and lend in the home country.
3. The domestic residents who repatriate capital funds previously sent abroad.
4. The domestic residents who receive gifts from abroad.

The main agents for demanding foreign exchange are:

1. The domestic residents – to import goods are services from abroad.
2. The domestic residents – to invest and lend abroad.
3. The foreign residents – to send gifts to foreign countries.

Determination of exchange rate:

E point is the equilibrium where demand schedule for foreign exchange equals supply schedule for foreign exchange. Hence, the equilibrium rate of exchange and traded quantity of foreign exchange are OR2 and OQ2, respectively. Any rate of exchange above or below OR2 will represent disequilibrium position and will be unstable.

For example, at an OR3 rate, demand for dollars (R3a) < Supply of dollars (R3b). It shows the condition of excess supply. It drives the market towards equilibrium and rate of exchange falls from OR3 to OR2.

Exchange rate

The rate of exchange measures the number of units of one currency which will exchange in foreign exchange market with another is called exchange rate. In other words, the foreign exchange rate is defined as the rate at which one currency is exchanged for the currency of other countries. The exchange rate is simply the price of one currency in terms of other.

Types of exchange rate

i. Spot rate: The rate of a foreign exchange contract for immediate delivery is known as spot rate. Spot rate is known as benchmark rates as well as straightforward rates or outright rates. Spot rates symbolize the price that a buyer anticipates to pay for a foreign currency in other currency.

ii. Forward rate: A rate appropriate to a financial transaction or operation that will take place in the future is known as forward rate. Forward rate is based on the spot rate, accustomed for the cost of carry and implies to the rate that will be used to deliver a currency, commodity or bond at the future time period. It may also refer to the rate fixed for a future financial obligation, such as the interest rate on a loan payment.

iii. Flexible rate: A flexible exchange-rate system refers to that monetary system that allows the exchange rate to be determined by supply and demand

iv. Fixed rate: A country's exchange rate regime under which the government or central bank ties the bureaucrat exchange rate to another country's currency or the price of gold. The main purpose of a fixed exchange rate system is to preserve a country's currency value within a very narrow band. Fixed rate is also known as pegged exchange rate.

v. Multiple rates: It refers to a system in which a country adopts more than one rate of exchange for its currency. Different exchange rates are fixed for importers, exporters and for different countries.

vi. Two tier rate: It is a form of multiple exchange rate system in which a country maintains two rates, a higher rate for commercial transactions and a lower rate for capital transactions.

vii. Long rate: A long rate of exchange is the rate at which a bank purchases or sells foreign currency bills which are payable at a fixed future date. The basis of the long rate of exchange is the interest on the delayed payment.

Reference

Bernake and Abel, Macroeconomics, Singapore, Pearson Education latest edition