Devaluation and Depreciation Definition

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Definition of devaluation and depreciation

  • A devaluation occurs when a country makes a conscious decision to lower its exchange rate in a fixed or semi-fixed exchange rate.
  • A depreciation is when there is a fall in the value of a currency in a floating exchange rate.

In general, everyday use, devaluation and depreciation are often used interchangeably. They both have the same effect – a fall in the value of the currency which makes imports more expensive, and exports more competitive.

depreciation-definition

In 2008, the Pound Sterling fell in value by 30%. The correct term is a depreciation because the Pound Sterling was a floating currency. (no fixed exchange rate.)

  • For A-Level economics, it is not absolutely essential to distinguish between the two, but there is a distinct technical difference and using them correctly is good practice.
  • Essentially devaluation is changing the value of a currency in a fixed exchange rate. A depreciation is reducing the value in a floating exchange rate.

Definition of Devaluation

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Sterling exchange rate index, which shows the value of Sterling against a basket of currencies. In 1992, The Pound devalued after exiting the Exchange Rate Mechanism.

A devaluation is when a country makes a conscious decision to lower its exchange rate in a fixed or semi-fixed exchange rate. Therefore, technically a devaluation is only possible if a country is a member of some fixed exchange rate policy.

  • For example in the late 1980s, the UK joined the Exchange Rate Mechanism ERM. Initially, the value of the Pound was set between say 3DM and 3.2DM.
  • However, if the government thought that was too high, they could make the decision to devalue and change the target exchange rate to 2.7DM and 2.9DM. In 1992, they left ERM as they couldn’t maintain the value of Pound.

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The impact of a falling exchange rate

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A look at the economic impact of a fall in the exchange rate (termed depreciation or devaluation)  A fall in the exchange rate is known as a depreciation in the exchange rate (or devaluation in a fixed exchange rate system). It means the currency is worth less compared to other countries. When there is a …

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How does US / China trade war affect EU, Asia and Africa?

Readers Question: To what extent does the trade war between USA and China actually impact on the economies of other nations? A trade war between the US and China is concerning for other countries because a trade war can precipitate a fall in global trade, and lead to lower investment, lower confidence and a drop …

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Costs and benefits of globalisation

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Globalisation is a complex and controversial issue. This is a look at some of the main benefits and costs associated with the greater globalisation of the world economy.

Definition of Globalisation The process of increased integration and co-operation of different national economies. It involves national economies becoming increasingly inter-related and integrated.

Globalisation has involved:

  • Greater free trade.
  • Greater movement of labour.
  • Increased capital flows.
  • The growth of multi-national companies.
  • Increased integration of global trade cycle.
  • Increased communication and improved transport, effectively reducing barriers between countries.

Summary of costs/benefits

BenefitsCosts
Lower prices/ greater choiceStructural unemployment
Economies of scale – lower pricesEnvironmental costs
Increased global investmentTax competition and avoidance
Free movement of labourBrain drain from some countries
May reduce global inequalityLess cultural diversity
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Benefits of globalisation

1. Free trade is a way for countries to exchange goods and resources. This means countries can specialise in producing goods where they have a comparative advantage (this means they can produce goods at a lower opportunity cost). When countries specialise there will be several gains from trade:

  1. Lower prices for consumers
  2. Greater choice of goods, e.g food imports enable a more extensive diet.
  3. Bigger export markets for domestic manufacturers
  4. Economies of scale through being able to specialise in certain goods
  5. Greater competition

See: Benefits of Free Trade

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What caused globalisation?

Readers Question: Evaluate the significance of the factors which have contributed to globalisation. Globalisation is not a new phenomenon. The world economy has become increasingly interdependent for a long time. However, in recent decades the process of globalisation has accelerated; this is due to a variety of factors, but important ones include improved trade, increased …

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Mercantilism theory and examples

Definition: Mercantilism is an economic theory where the government seeks to regulate the economy and trade in order to promote domestic industry – often at the expense of other countries. Mercantilism is associated with policies which restrict imports, increase stocks of gold and protect domestic industries. Mercantilism stands in contrast to the theory of free …

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Criticisms of WTO

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The World Trade Organisation (WTO) is committed to improving free trade amongst its member countries. However, its role has been controversial –  creating polarised views. These are some of the criticisms of the WTO Free Trade benefits developed countries more than developing countries. It is argued, developing countries need some trade protection to be able …

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The importance of international trade

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International trade between different countries is an important factor in raising living standards, providing employment and enabling consumers to enjoy a greater variety of goods. International trade has occurred since the earliest civilisations began trading, but in recent years international trade has become increasingly important with a larger share of GDP devoted to exports and …

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