An appreciation makes exports dearer and imports cheaper; a depreciation makes exports cheaper and imports dearer.
When a currency appreciates, foreigners need more of their own currency to buy the country's exports, so exports become dearer abroad. Demand for exports tends to fall. Imports become cheaper for residents, so demand for imports tends to rise.
When a currency depreciates, exports become cheaper abroad, so demand for them tends to rise. Imports become dearer, so demand for them tends to fall.
These changes matter for firms and jobs. A depreciation can help exporters sell more and hire more workers. An appreciation helps consumers and firms that rely on imported goods, and can lower inflation.
How much demand changes depends on price elasticity of demand. If demand for exports is inelastic, a change in their price changes the quantity sold only a little.
- Appreciation
- Exports dearer, imports cheaper.
- Depreciation
- Exports cheaper, imports dearer.
- Size of effect
- Depends on price elasticity of demand.
Worked example: Working out the price effect
A Singapore-made machine sells for S$10,000. The rate moves from S$1 = US$0.75 to S$1 = US$0.80.
- Before: price in the US = 10,000 x 0.75 = US$7,500.
- After: price in the US = 10,000 x 0.80 = US$8,000.
- The S$ appreciated, so the machine became dearer for American buyers.
- American demand for the machine is likely to fall, though by how much depends on PED.
Watch out for this
A strong currency is always good for a country.
A strong currency helps consumers and importers and can reduce inflation, but it makes exports dearer, which can hurt exporters and jobs.
Check your understanding
A country's currency depreciates. What is the likely effect?
- Exports become cheaper abroad and imports become dearer.
- Exports become dearer abroad and imports cheaper.
- Both exports and imports become cheaper.