ENC 500 SEU Currency Depreciation Essay

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In a critical essay, analyze how currency depreciation stimulates exports. Evaluate the three major approaches to analyzing the economic impact of currency depreciation: the elasticities approach, the absorption approach, and the monetary approach. Compare and contrast the three approaches and provide examples that distinguish them from each other. Use APA Style

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INTERNATIONAL
ECONOMICS
SEVENTEENTH EDITION
ROBERT J. CARBAUGH
© 2019 Cengage. All rights reserved.
1
Chapter 13
ExchangeRate
Adjustments
and the
Balance of
Payments
© 2019 Cengage. All rights reserved.
2
Chapter Outline (1 of 2)
Effects of Exchange-Rate Changes on
Costs and Prices
Cost-Cutting Strategies of Manufacturers in
Response to Currency Appreciation
Will Currency Depreciation Reduce a Trade
Deficit? The Elasticity Approach
J-Curve Effect: Time Path of Depreciation
Exchange Rate Pass-Through
© 2019 Cengage. All rights reserved.
3
Chapter Outline (2 of 2)
The Absorption Approach to Currency
Depreciation
The Monetary Approach to Currency
Depreciation
© 2019 Cengage. All rights reserved.
4
Effects of Exchange-Rate Changes
on Costs and Prices (1 of 10)
How do exchange-rate fluctuations affect
relative costs?
• Depends on whether firm’s costs are
denominated in home or foreign currency
Case 1: No foreign sourcing?all costs
denominated in dollars
• If the dollar appreciates by 100%, the U.S.
firm’s production costs also rise by 100%
• Reduced international competitiveness
© 2019 Cengage. All rights reserved.
5
Effects of Exchange-Rate Changes
on Costs and Prices (2 of 10)
TABLE 13.1 Effects of a Dollar Appreciation on a U.S. Steel Firm’s
Production Costs When All Costs Are Dollar Denominated
COST OF PRODUCING A TON OF STEEL
PERIOD 1 $0.50 PER FRANC
(2 FRANCS = $1)
Dollar Cost
Labor
$160
Franc Equivalent
320 francs
PERIOD 2 $0.25 PER FRANC
(4 FRANCS = $1)
Dollar Cost
$160
Franc Equivalent
640 francs
Materials (iron/coal)
300
600
300
1,200
Other costs (energy)
40
80
40
160
Total
Percentage change
$500
1,000 francs
$500
—
—
—
© 2019 Cengage. All rights reserved.
2,000 francs
100%
6
Effects of Exchange-Rate Changes
on Costs and Prices (3 of 10)
• Case 2: Foreign sourcing—some costs
denominated in dollars and some in francs
• If dollar appreciates by 100%, for U.S. firm:
• Production costs in francs increase by 100% for
inputs denominated in dollars
• Production costs in francs stay the same for inputs
denominated in francs
• Overall, production costs are higher (by less than
100%)
• International competitiveness is reduced
© 2019 Cengage. All rights reserved.
7
Effects of Exchange-Rate Changes
on Costs and Prices (4 of 10)
TABLE 13.2 Effects of a Dollar Appreciation on a U.S. Steel Firm’s Production Costs
When Some Costs Are Dollar Denominated and Other Costs Are Franc Denominated
COST OF PRODUCING A TON OF STEEL
PERIOD 1 $0.50 PER FRANC
(2 FRANCS = $1)
Labor
Materials
$ denominated
(iron/coal)
Franc denominated
(scrap iron)
Total
Other costs (energy)
Total cost
Percentage change
Dollar Cost
$160
Franc Equivalent
320 francs
PERIOD 2 $0.25 PER FRANC
(4 FRANCS = $1)
Dollar Cost
$160
Franc Equivalent
640 francs
120
240
120
480
180
360
90
360
300
40
$500
—
600
80
1,000 francs
—
© 2019 Cengage. All rights reserved.
210
40
$410
?18%
840
160
1,640 francs
+64%
8
Effects of Exchange-Rate Changes
on Costs and Prices (5 of 10)
• Generalization
• As franc-denominated costs become larger
portion of Nucor’s total costs, dollar
appreciation (depreciation) leads to
• Smaller increase (decrease) in franc cost of Nucor
steel
• Larger decrease (increase) in dollar cost of Nucor
steel compared to cost changes that occur when
all input costs are dollar denominated
© 2019 Cengage. All rights reserved.
9
Effects of Exchange-Rate Changes
on Costs and Prices (6 of 10)
• Exchange-rate fluctuations cause changes in
relative costs
• Influencing relative prices and volume of goods
traded among nations
© 2019 Cengage. All rights reserved.
10
Effects of Exchange-Rate Changes
on Costs and Prices (7 of 10)
• Dollar depreciation lowers U.S. production costs
• Lowers export prices in foreign currency terms
• Induces increase in U.S. goods sold abroad
• Dollar depreciation leads to decrease in U.S. imports
© 2019 Cengage. All rights reserved.
11
Effects of Exchange-Rate Changes
on Costs and Prices (8 of 10)
• Dollar depreciation lowers U.S. production costs and
thus export prices in foreign currency terms
• Induces increase in U.S. goods sold abroad
• Dollar depreciation leads to decrease in U.S. imports
© 2019 Cengage. All rights reserved.
12
Effects of Exchange-Rate Changes
on Costs and Prices (9 of 10)
• Factors influencing extent to which exchangerate movements lead to relative price changes
• U.S. exporters can offset price-increasing effects of
appreciation by reducing profit margins
• Perceptions of long-term trends in exchange rates
may promote price rigidity if appreciation seen as
temporary
© 2019 Cengage. All rights reserved.
13
Effects of Exchange-Rate Changes
on Costs and Prices (10 of 10)
• Factors influencing extent to which exchangerate movements lead to relative price changes
(cont’d)
• If product not highly substitutable, producers can
exercise greater control over price
• Production can be moved offshore, to countries
whose currencies have depreciated against home
country currency
© 2019 Cengage. All rights reserved.
14
Cost-Cutting Strategies of Manufacturers in
Response to Currency Appreciation (1 of 6)
Appreciation of yen: Japanese
manufacturers
• 1990–1996, Japanese yen relative to U.S.
dollar increased by 40%
• Japanese firms
• Establish integrated manufacturing bases in the
U.S. and in dollar-linked Asia
• Use cheaper dollar-denominated parts and materials
• Purchase cheaper components from around the world
• Shifted production from commodity-type goods to
high-value products
© 2019 Cengage. All rights reserved.
15
Cost-Cutting Strategies of Manufacturers in
Response to Currency Appreciation (2 of 6)
• Appreciation of the yen: Japanese
manufacturers
• Hitachi TV Sets
•
•
•
•
Parts from SC and Malaysia
Japan supplied computer chips
Only 30% of supplies came from Japan
TV price stayed low despite rising yen
© 2019 Cengage. All rights reserved.
16
Cost-Cutting Strategies of Manufacturers in
Response to Currency Appreciation (3 of 6)
© 2019 Cengage. All rights reserved.
17
Cost-Cutting Strategies of Manufacturers in
Response to Currency Appreciation (4 of 6)
• Appreciation of yen: Japanese
manufacturers (cont.)
• Japanese auto industry
• Cut the yen prices of their autos
• Falling unit-profit margins
• Reduced manufacturing costs
• Increasing worker productivity
• Importing materials and parts
• Outsourcing larger amounts of a vehicle’s production to
transplant factories
© 2019 Cengage. All rights reserved.
18
Cost-Cutting Strategies of Manufacturers in
Response to Currency Appreciation (5 of 6)
• Appreciation of dollar: U.S. manufacturers
• 1996–2002, dollar appreciated by 22%
• American Feed Co.
• Napoleon, Ohio
• Made machinery used in auto plants
• when orders come in, two companies meet to
decide which plant should make which parts
• American Feed can share in the benefits of having
a European production base without having to take
on risks of building its own factory there
© 2019 Cengage. All rights reserved.
19
Cost-Cutting Strategies of Manufacturers in
Response to Currency Appreciation (6 of 6)
• Appreciation of dollar: U.S. manufacturers
• Sipco Molding Technologies
• Partnership with an Austrian company
• Austrian company designed and made the tools
• Sipco simply resold them
© 2019 Cengage. All rights reserved.
20
Will Currency Depreciation Reduce a Trade
Deficit? The Elasticity Approach (1 of 7)
Currency depreciation
• Improves nation’s competitiveness by
reducing its costs and prices
Elasticity approach
• Emphasizes relative price effects of
depreciation
• Depreciation works best when demand
elasticities are high
© 2019 Cengage. All rights reserved.
21
Will Currency Depreciation Reduce a Trade
Deficit? The Elasticity Approach (2 of 7)
• Absorption approach
• Focuses on income effects of depreciation
• Decrease in domestic expenditure relative to
income must occur for depreciation to
promote trade equilibrium
• Monetary approach
• Stresses effects of depreciation on purchasing
power of money and resulting impact on
domestic expenditure
© 2019 Cengage. All rights reserved.
22
Will Currency Depreciation Reduce a Trade
Deficit? The Elasticity Approach (3 of 7)
• Elasticity of demand
• Responsiveness of buyers to changes in price
• Percentage change in quantity demanded
stemming from 1% change in price
• >1, elastic demand
•
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Economic Impact

Currency Depreciation

Elasticities approach

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