Description
ECON Module 12: Critical Thinking ( Exchange Rate Adjustments and the Balance of Payments)
Currency Depreciation
Exchange rate fluctuation may affect industries that are in direct competition with foreign producers or rely on their supplies. Specifically, international competitiveness is affected through the influence the exchange rate has on relative costs. In a critical essay, assume that the following four events are taking place:
-Americans increase their travel to Europe.
-Saudi investors purchase large amounts of U.S. stocks
-U.S. interest rates increase suddenly because of a relative increase of world interest rates
-Other countries experience economic and political turmoil and become less stable when compared to the United States. Then, please answer the following questions:
-How will each event affect the foreign exchange market?
-Will your answer be different if the currency was pegged?
-Please explain if a dirty float system will change your assessment
- Your essay is required to be five to six pages in length, which does not include the title page and reference pages, which are never a part of the content minimum requirements.
- Support your submission with course material concepts, principles, and theories from the textbook and at least three scholarly, peer-reviewed journal articles. Use the Saudi Digital Library to find your resources.
- Use Saudi Electronic University academic writing standards and follow APA style guidelines.
- It is strongly encouraged that you submit all assignments into Turnitin prior to submitting them to your instructor for grading. If you are unsure how to submit an assignment into the Originality Check tool, review the Turnitin – Student Guide for step-by-step instructions.
Review the grading rubric to see how you will be graded for this assignment.
This module will examine the effect of exchange rate adjustments on the balance of trade. You will learn when currency depreciation (appreciation) improves (worsens) a nation’s trade position. We will explore the main insights of the elasticity, absorption, and monetary approaches. We will also discuss the automatic adjustments in prices, interest rates, and incomes.
Learning Outcomes
- Analyze how the exchange rate adjustments affect the Balance of Payments.
- Evaluate how currency depreciation stimulates exports.
Readings
Required:
Chapter 13 in International Economics
Sule, I., & Shuaibu, M. (2020). Current account behavior, real exchange rate adjustment and relative output in Nigeria. Journal of Economic Development, 45(3), 77-99.
Emerging markets monitor. (2017). 23(29), 1-23.
Recommended:
Chapter 13 PowerPoint slides
Rappeti, M. (2020). The real exchange rate and economic growth: a survey. Journal of Globalization and Development, 11(1).
Exchange-Rate Adjustments
and the Balance of Payments
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
1
Chapter Outline
13-1 Effects of Exchange-Rate Changes on Costs and Prices
13-2 Cost-Cutting Strategies of Manufacturers in Response to Currency
Appreciation
13-3 Will Currency Depreciation Reduce a Trade Deficit? The Elasticity Approach
13-4 J-Curve Effect: Time Path of Depreciation
13-5 Exchange-Rate Pass-Through
13-6 The Absorption Approach to Currency Depreciation
13-7 The Monetary Approach to Currency Depreciation
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
2
13-1
Effects of Exchange-Rate Changes on Costs and
Prices
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
3
Case 1
• No foreign sourcing; all costs denominated in dollars
• If the dollar appreciates by 100%, the U.S. firm’s production costs also rise
by 100%
• Reduced international competitiveness
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
4
Table 13.2 Cost of Producing a Ton of Steel: Effects of a Dollar
Appreciation on a U.S. Steel Firm’s Production Costs When
Some Costs Are Dollar Denominated and Other Costs Are Franc
Denominated (1 of 2)
Period 1 $0.50 per Franc
(2 Francs = $1)
Dollar Cost
Franc Equivalent
Period 2 $0.25 per Franc
(4 Francs = $1)
Dollar Cost
Franc Equivalent
Labor
160
320
160
640
Materials (iron/coal)
300
600
300
1,200
Other costs (energy)
40
80
40
160
Total
500
1,000
500
2,000
Percentage change
—
—
—
100%
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
5
Case 2
• Foreign sourcing; some costs denominated in dollars, and some in francs
• If dollar appreciates by 100%, for U.S. firm:
• Production costs in francs increase by 100% for inputs denominated in dollars
• Production costs in francs stay the same for inputs denominated in francs
• Overall, production costs are higher (by less than 100%)
• International competitiveness is reduced
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
6
Table 13.2 Cost of Producing a Ton of Steel: Effects of a Dollar
Appreciation on a U.S. Steel Firm’s Production Costs When
Some Costs Are Dollar Denominated and Other Costs Are Franc
Denominated (2 of 2)
Period 1 $0.50 per Franc (2 Francs = $1)
Dollar Cost
Labor
Materials
$ denominated
(iron/coal)
Franc denominated
(scrap iron)
Total
Other costs (energy)
Total cost
Percentage change
Franc Equivalent
Period 2 $0.25 per Franc (4 Francs = $1)
Dollar Cost
Franc Equivalent
160
320
160
640
120
240
120
480
180
360
90
360
300
40
500
—
600
80
1,000
—
210
40
410
840
160
1,640
+64%
−18%
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
7
13-2
Cost-Cutting Strategies of Manufacturers in
Response to Currency Appreciation
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
8
Appreciation of the Yen: Japanese
Manufacturers
• 1990–1996, Japanese yen relative to U.S. dollar increased by 40%
• Japanese firms
• Establish integrated manufacturing bases in the U.S. and Asia
• Shifted production from commodity-type goods to high-value products
• Japanese auto industry
• Cut the yen prices of their autos
• Falling unit-profit margins
• Reduced manufacturing costs
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
9
Figure 13.1 How Hitachi Coped with the
Yen’s Appreciation
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
10
Appreciation of the Dollar: U.S.
Manufacturers
• 1996–2002, dollar appreciated by 22%
• U.S. manufacturers sought ways to tap overseas markets and defend their
home turf
• Examples:
• American Feed Co., Napoleon, Ohio
• Partnership with Spanish company
• Sipco Molding Technologies
• Partnership with Austrian company
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
11
Discussion Activity (1 of 2)
Japanese Firms Send Work Abroad as Rising Yen Makes Their Products
Less Competitive
• How can moving production to the United States help Japanese
producers avoid the problem of an appreciation of the yen?
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
12
13-3
Will Currency Depreciation Reduce a Trade
Deficit? The Elasticity Approach
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
13
Currency Depreciation: Improving
Competitiveness
Elasticity approach
• Emphasizes relative price effects of depreciation
• Depreciation works best when demand
elasticities are high
Absorption approach
• Focuses on income effects of depreciation
• Decrease in domestic expenditure relative to
income must occur for depreciation to promote
trade equilibrium
Monetary approach
• Stresses effects of depreciation on purchasing
power of money and resulting impact on
domestic expenditure
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
14
Marshall-Lerner Condition (1 of 2)
1. Depreciation will improve the trade balance if the currency-depreciating
nation’s demand elasticity for imports plus the foreign demand elasticity for the
nation’s exports exceeds 1.0
2. If the sum of the demand elasticities is less than 1.0, depreciation will worsen
the trade balance
3. The trade balance will be neither helped nor hurt if the sum of the demand
elasticities equals 1.0
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
15
Marshall-Lerner Condition (2 of 2)
• Simplifying assumptions
• A nation’s trade balance is in equilibrium when depreciation occurs
• No change in the sellers’ prices in their own currency
• Illustrates the price effects of currency depreciation on the home country’s
trade balance
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
16
Table 13.4 Long-Run Price Elasticities of
Demand for Total Imports and Exports of
Selected Countries
Country
Import Price
Elasticity
Export Price
Elasticity
Sum of Import and
Export Elasticities
Canada
0.9
0.9
1.8
France
0.4
0.2
0.6
Germany
0.1
0.3
0.4
Italy
0.4
0.9
1.3
Japan
0.3
0.1
0.4
United Kingdom
0.6
1.6
2.2
United States
0.3
1.5
1.8
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
17
13-4
J-Curve Effect: Time Path of Depreciation
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
18
J-Curve Effect
• Currency depreciation leads to worsening of nation’s trade balance in short run
• Trade balance likely improves because of lags between changes in relative
prices and quantities of goods traded as time passes
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
19
Figure 13.2 Depreciation Flowchart
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
20
Types of Lags
• Recognition lags
• Decision lags
• Delivery lags
• Replacement lags
• Production lags
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
21
13-5
Exchange-Rate Pass-Through
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
22
Pass-Throughs
• Extent to which changing currency values lead to changes in import and export
prices
• Buyers have incentive to alter purchases of foreign goods only to extent that
prices of foreign goods change in terms of buyers’ domestic currency
• This change depends in part on exporters’ willingness to change prices they
charge for goods measured in buyers’ currency
Robert J. Carbaugh, International Economics, Eighteenth Edition. © 2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
23
Partial Exchange-Rate Pass-Through
• Percentage change in import prices
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