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Economic Effect of a Devaluation of the Currency
Economic Revision Notes
1. A devaluation of the exchange rate will make exports more competitive and appear cheaper to foreigners. This will increase demand for exports
2. Imports will become more expensive. This will reduce demand for imports
3. AD= X-M Therefore higher exports and lower imports will increase AD
Higher AD is likely to cause higher Real GDP and inflation.
Evaluation The size of this increase depends upon factors such as:
a) Spare capacity in the economy
b) Other determinants of AD
4. Inflation is likely to occur because:
i) Imports are more expensive
ii) AD is increasing
iii) With exports becoming cheaper manufacturers may have less incentive to cut costs and become more efficient
Evaluation:
The effect on inflation will depend on other factors such as
iv) Spare capacity in the economy
v) Do firms pass increased import costs onto consumers
vi) Import prices are not the only determinant of inflation.
Other factors affecting inflation such as wage increases may be important
5. There is likely to be an improvement in the current account balance of payments.
This is because exports are increasing and imports are falling
Evaluation
However an improvement in the Balance of Payments depends upon the Marshall Lerner condition and the elasticity of demand for exports and imports
- If PEDx + PEDm > 1 then a devaluation will improve the current account
Essays and Revision Notes on Exchange Rates
Exchange Rates revision notes and essays
Factors influencing exchange rates
Determination of exchange rates in free markets
International Trade Revision Notes
Exchange Rate Essays
- Effects of a falling Dollar
- Why Dollar keeps falling
- Discuss Policies to Stop the Dollar Falling
- Does Devaluation Cause Inflation?