What does it mean to say that, at an exchange rate of 1 USD = 80 INR, the U.S. d

Question

What does it mean to say that, at an exchange rate of 1 USD = 80 INR, the U.S. dollar is overvalued and the Indian rupee is undervalued? A. The dollar is worth less rupee than it would be under a flexible exchange rate system; thus, the quantity of dollars supplied exceeds the quantity of dollars demanded. B. The dollar is worth less rupee than it would be under a flexible exchange rate system; thus, the quantity of dollars supplied is less than the quantity of dollars demanded. C. The dollar is worth more rupee than it would be under a flexible exchange rate system; thus, the quantity of dollars supplied is less than the quantity of dollars demanded. D. The dollar is worth more rupee than it would be under a flexible exchange rate system; thus, the quantity of dollars supplied exceeds the quantity of dollars demanded.

Explanation / Answer

Option B is correct.

Undervaluation means that its value in foreign exchange is less than it should be at the given exchange rate system. This is due to the demand for the currency (which is undervalued) is insufficient, if no one wants to buy that currency, the value of it would fall below the supply.

Similarly, if the currency is overvalued it means that the demand for that currency exceeds the supply and there is excess demand for it.

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