How does the exchange rate affect imports and exports?
A weaker domestic currency stimulates exports and makes imports more expensive; conversely, a strong domestic currency hampers exports and makes imports cheaper.
It means the currency is worth less compared to other countries. For example, a depreciation of the dollar makes US exports more competitive but raises the cost of importing goods into the US. Therefore there will be an increase in exports and decrease in the quantity of imports.
When exchange rates change, the prices of imported goods will change in value, including domestic products that rely on imported parts and raw materials. Exchange rates also impact investment performance, interest rates, and inflation—and can even extend to influence the job market and real estate sector.
In the goods market, a positive shock to the exchange rate of the domestic currency (an unexpected appreciation) will make exports more expensive and imports less expensive. As a result, the competition from foreign markets will decrease the demand for domestic products, decreasing domestic output and price.
A country's balance of trade is defined by its net exports (exports minus imports) and is thus influenced by all the factors that affect international trade. These include factor endowments and productivity, trade policy, exchange rates, foreign currency reserves, inflation, and demand.
Imports cheaper: When a currency appreciates or strengthens in relation to other currencies, imports get cheaper. This means your dollar will buy more of another foreign currency so that you can purchase foreign goods.
Current-dollar GDP: When the dollar depreciates against major foreign currencies, one generally expects to see current-dollar exports increase, as U.S. produced goods become cheaper abroad.
A fall in the exchange rate should reduce the terms of trade. This is because a decline in the exchange rate will make exports cheaper. An appreciation in the exchange rate should improve the terms of trade because exports will rise in price and imports become cheaper.
Effects of Currency Appreciation
Export costs rise: If the U.S. dollar appreciates, foreigners will find American goods more expensive because they have to spend more for those goods in USD. That means that with the higher price, the number of U.S. goods being exported will likely drop.
In general, a weaker currency makes imports more expensive, while stimulating exports by making them cheaper for overseas customers to buy. A weak or strong currency can contribute to a nation's trade deficit or trade surplus over time.
Why do changing exchange rates help one country and hurt the other?
The exchange rate is also important because it can help or hurt specific interests within a country: exporters tend to be helped (hurt) by a weak (strong) domestic currency because they will sell more (less) abroad, while consumers are hurt (helped) by a strong currency because imported goods will be more (less) ...
For entrepreneurs, changes in exchange rates affect their businesses in two main ways: by changing the cost of supplies that are purchased from a different country, and by changing the attractiveness of their products to overseas customers.
A rise in the real exchange rate (a depreciation of domestic currency) means that domestic goods are cheaper compared to foreign goods, so exports increase and imports decrease.
The economics of supply and demand dictate that when demand is high, prices rise and the currency appreciates in value. In contrast, if a country imports more than it exports, there is relatively less demand for its currency, so prices should decline. In the case of currency, it depreciates or loses value.
Overview of Exchange Rates
A lower-valued currency makes a country's imports more expensive and its exports less expensive in foreign markets. A higher exchange rate can be expected to worsen a country's balance of trade, while a lower exchange rate can be expected to improve it.
A weak domestic currency makes a nation's exports more competitive in global markets, and simultaneously makes imports more expensive. Higher export volumes spur economic growth, while pricey imports also have a similar effect because consumers opt for local alternatives to imported products.
How does one explain the changing slope of the aggregate supply (AS) curve? The AS curve is more horizontal when the economy is below full employment and is more vertical when the economy is running at full employment.
Fiscal expansion under fixed exchange rates will have what temporary effect? the exchange rate will decrease.
Expansionary fiscal policy in a fixed exchange rate system will cause an increase in GNP, no change in the exchange rate (of course), and a decrease in the current account balance.