Separate export demand, import costs and the final outcome.
An appreciation means one unit of domestic currency buys more foreign currency. With foreign-currency input prices unchanged, imports become cheaper in domestic currency; this can reduce production costs and consumer-price pressure. Domestic exports may become more expensive to foreign buyers if firms keep domestic-currency prices unchanged. Depreciation reverses these price channels. Demand responsiveness, pricing decisions, imported content and timing determine the eventual effects.
- Appreciation and depreciation
- Appreciation means one unit of domestic currency buys more foreign currency; depreciation means it buys less. If seller-currency prices stay fixed, appreciation makes imports cheaper locally and exports dearer to overseas buyers.
- Prices and quantities
- Check how the exchange rate is quoted and whether firms change prices. Cheaper imported inputs can help an exporter even while its overseas sales face pressure; the overall output or profit effect is not automatic.
Keep the quotation and assumptions explicit
Quotation
With foreign currency per domestic dollar, a rise means appreciation. With domestic dollars per foreign unit, appreciation appears as a fall. State which quotation is used.
Pricing decisions
Firms may absorb part of a currency change by adjusting the amount left from each sale after costs, rather than changing the buyer's price fully. Existing contracts can also delay price changes.
Imported content
A stronger currency can lower the local cost of imported inputs, partly offsetting exporters' reduced price competitiveness. A weaker currency can do the reverse.
Separate channels
Cheaper imported inputs can lower production costs and improve AS. Changes in spending on exports or locally produced alternatives to imports affect AD. These are separate cost and spending channels.
| Item | Before | After |
|---|---|---|
| Imported input at 60 foreign dollars | 120 domestic dollars | 100 domestic dollars |
| Export at 100 domestic dollars | 50 foreign dollars | 60 foreign dollars |
Worked example: An exporter buys an imported input
One domestic dollar initially buys 0.50 foreign dollars, then 0.60. An imported input costs 60 foreign dollars. A domestic export keeps its price of 100 domestic dollars.
- The currency appreciates. Divide the foreign input price by foreign currency per domestic dollar: 60/0.50 = 120 domestic dollars initially; 60/0.60 = 100 later. This input becomes cheaper.
- Multiply the domestic export price by that exchange rate: 100 x 0.50 = 50 foreign dollars initially; 100 x 0.60 = 60 later. The dearer foreign price can weaken export demand.
- Cheaper inputs can partly offset exporters' cost pressures, so net competitiveness and output depend on the full circumstances.
Watch out for this
An appreciation means every export firm must lose and every retail price must fall immediately.
Imported inputs, margins, contracts and pass-through differ. Explain the price channels, then assess their strength and timing.
Check your understanding
Which is a direct price effect of appreciation under unchanged foreign-currency import prices?
- More domestic currency is needed to buy the same foreign-priced input.
- Less domestic currency is needed to buy the same foreign-priced input.
- The physical quantity of every import must fall.