Chapter – 42

IMPACT OF CHANGING EXCHANGE RATES

AUNTORIP KARIM - CLASS IX ECONOMICS - CHAPTER 42

Currency Appreciation (Strong)
Appreciation of a currency means the value of one currency increasing in terms of another
currency e.g. £1 = $1.50 changes to £1 = $2. The pound (£) has appreciated in value.
It also means that the UK citizens can now buy more dollars with fewer pounds than before.

Currency Depreciation (Weak)

Depreciation of a currency means the value of one currency decreasing in terms of another currency
e.g. £1 = $1.50 changes to £1 = $1.20. The pound (£) has depreciated in value.
It also means that the UK citizens have to pay more pounds to buy dollars than before.

AUNTORIP KARIM - CLASS IX ECONOMICS - CHAPTER 42

AUNTORIP KARIM - CLASS IX ECONOMICS - CHAPTER 42
Economic effects of an appreciation in the currency

 Import & Export: When the currency appreciates, imports become cheaper and export becomes expensive. As a
result, demand for exports fall and the demand for imports rises. However, the extent of the volume changed
depends upon the price elasticity of demand for both imports and exports.
 Lower Inflation: A strong exchange rate helps to control the rate of inflation because domestic suppliers now face
stiffer international competition from cheaper imports and will try to be efficient and reduce their costs. Stronger
exchange rate makes it cheaper to import raw materials, component parts and capital inputs thus reducing cost push
inflation.
 Economic Growth: A stronger exchange rate reduces the demand for exports whilst imports rise. Thus, Aggregate
demand falls. This slows down economic growth.
 Unemployment: An appreciation of the currency causes the demand for exports to fall. Firms in the export sector will
cut down production and as a result, lay off workers. As more cheap imports enter the country, consumers will spend
more time on cheap imported goods, as a result domestic firms will lose out and their revenues will fall. They will
also reduce the number of workers employed. Thus, Unemployment will rise.
 Balance of Current Account: A rise in the exchange rate will increase the demand for imports as they are cheaper
and decrease the demand for export as they are expensive. This will worsen the balance of current account and might
cause a deficit.

AUNTORIP KARIM - CLASS IX ECONOMICS - CHAPTER 42

 Economic effects of Depreciation in the currency
 Import & Export: Import prices will rise on the other hand export prices will fall. Therefore, Exports
would rise and imports would fall. However, the extent of the volume changed depends on the price
elasticity of demand for both imports and exports.
 Inflation: Cost push inflation may occur as raw material imports will become more expensive.
Aggregate demand will rise as exports become more price competitive and imports less price
competitive. As a result, Demand Pull inflation will tend to increase.
 Economic Growth: A fall in the exchange rare will lead to rising exports and falling imports, raising
Aggregate demand, this simulating economic growth.
 Unemployment: Since exports become more competitive, firms will hire more workers in the export-
oriented industries. Similarly, domestic firms will also hire more workers as consumers find imports
expensive. Thus, unemployment in the economy falls.
 Balance of Current Account: A fall in the exchange rate is likely to lead an improvement in the
Balance of Current account in the short run as exports rise and imports fall

AUNTORIP KARIM - CLASS IX ECONOMICS - CHAPTER 42

Effect on Export & Import:

Currency Depreciates Price of Export Demand for Export

Currency Appreciates Price of Import Demand for Import

AUNTORIP KARIM - CLASS IX ECONOMICS - CHAPTER 42

 Relationship between Price Elasticity of Demand and Balance of Current Account
 Depreciation of the currency leads to a fall in imports since they are expensive and a rise in
exports as they become cheaper. This will improve the Balance of Current Account.
However, the balance of current account deficit will only improve if the price elasticity of
demand for exports and imports is elastic.
 Appreciation of the currency leads to a rise in imports since they are cheaper and a fall in
exports as they become expensive. This will worsen the Balance of Current account.
However, if the price elasticity of demand for exports is inelastic, there will be less
impact on the current account.

AUNTORIP KARIM - CLASS IX ECONOMICS - CHAPTER 42

Q. Asses the effect of taka’s depreciation on the balance of payment of Bangladesh
Answer:
Depreciation of the currency will make exports cheaper and imports expensive. This will
increase the demand for exports and decrease the demand for imports and thus improve the
balance of payment of current A/C. Rising exports and falling imports will reduce
unemployment as firms will demand for more workers to produce the output. Higher GDP will
also stimulate economic growth.
On the other hand, the balance of payment of current A/C will only improve if the PED for
exports and imports is price elastic. Similarly, if the good is a necessity and has price inelastic
demand, e.g. oil then demand for imports will fall less than proportionately following a rise in
price due to currency depreciation. Exports may not rise if the export lacks non price
competitiveness such as quality, design, etc.
However, a weaker currency will make raw materials import expensive and lead to cost push
inflation. Demand pull inflation may also occur as AD increases due to rise in exports.
In conclusion, there will be a time lag in experiencing these effects in the economy.

AUNTORIP KARIM - CLASS IX ECONOMICS - CHAPTER 42

 THE END

AUNTORIP KARIM - CLASS IX ECONOMICS - CHAPTER 42