Changing exchange rates & government policy Chapter 51.

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Presentation transcript:

Changing exchange rates & government policy Chapter 51

Why do exchange rates change?  Note down 5 reasons (from Ch. 50) *do getting started

Impact of changing exchange rates Currency value↓↑ Importsdearer so ↓ Qdcheaper so ↑ Qd Exportscheaper so ↑ Qddearer so↓ Qd Balance of paymentsimprovesworsens (3: 30)

Example 1US$ = THB THB Rice70/35 = $270/30 = $2.33 Jeans$20 * 35 baht = 700 baht$20 * 30 baht = 600 baht How can we describe the change in the exchange rate? THB has appreciated (against the $). US$ has depreciated (against THB) Let’s say; Thailand exports 70 baht per bag Thailand imports Levis US$20 baht per pair Calculate the price of rice in the US & jeans in Thailand for 2009 & 2010 So what is the effect on Qd of X & M for Thailand? *do Q1 & Q2

Exchange rates and government policy  If a country has a problem with an ongoing Balance of Payments (Current Account), deficit i.e. M > X the government can use currency devaluation (fall in value of a currency) to make exports cheaper and imports dearer.  How?  ↓ i/r’s → ↓ foreign investment → ↓ demand for currency → ↓ value of the currency  But this policy may not be effective because;  govt. may not have full control over i/r’s (UK’s set by MPC)  may affect other monetary policy objectives, especially inflation.  depends on the price elasticity of demand for X’s & M’s.

Exchange rates and price elasticity  If a currency ↓ in value what happens to the quantity demanded of X & M? XX MM  but by how much?  Depends on the price elasticity of demand (PED) for the X & M’s.  Can you define PED?

Which of these is price elastic/ inelastic & why? elasticitywhy Food Samsung galaxy tablet Petrol Overseas travel

Elasticity & effect on X & M  Primary goods are price inelastic → ↓ currency value has little effect on quantity traded → ↓ Total Revenue  Non –essential / luxury goods & services are price elastic → ↓ currency value has big effect on quantity traded →  total revenue  Therefore we can see that currency devaluation in many developed countries which import more primary products, and export more tertiary and luxury products, e.g. UK, will not be very effective in improving their Balance of Payments. *do exam practice