Question

Between 2002 and 2005, French wine exports to the United States dropped by nearly 18 percent. Some wine experts blamed part of the decline on what they perceived to be a drop in the quality of French wine. Others blamed a shift in U.S. tastes in favor of domestic wines, and others suggested U.S. residents’ unhappiness with the French government’s foreign policies.

Economists offered a different explanation. During 2003, the dollar depreciated by almost 20 percent relative to the euro. Even if the euro price of a bottle of French wine remained the same, U.S. residents would have seen its dollar price rise by nearly 20 percent. The effective increase in the U.S. price of French wines resulted in a decrease in the quantity of French wine demanded by U.S. residents. Thus, French wine exports to the United States decreased.

What do you predict will happen to French wine exports to the United States, other things being equal, if the dollar appreciates considerably in relation to the euro?

Answer 1

Ans. French wine exports to the United States will increase or in other words Import of French wines will increase. The reason being the effective price of french wines for the U.S residents will decrease. As per law of demand(All other things being equal) demand for French wines will increase. But as demand of wine is relatively inelastic percentage increase in its demand will be less than percentage decrease in its effective price due to appreciation in the value of Dollar in terms of Euro.

let us understand it with the help of an example.

At Present 1 Euro = $1.18 and assuming price of French wine bottle is 20 EUROS ,An American resident will have to pay ( 20 * 1.18 ) = $23.6 to buy a bottle of French wine.

Now if Dollar appreciates Considerably (which means now U.S residents will have to pay much less to exchange their Dollars with Euros) and exchange rate becomes 1 Euro = $ 0.75. An American Resident will now have to pay (20 * 0.75) $15 to buy a bottle of french wine. As a result demand for French wines will increase.

But as demand of wine is relatively inelastic percentage increase in its demand will be less than percentage decrease in its effective price due to appreciation in the value of Dollar in terms of Euro. If we read the question carefully as a result of 20% rise in dollar price of French wine has resulted into 18% decline in its demand. This shows demand for French wines in U.S is relatively inelastic.

As Dollar has appreciated in terms of Euro, Import of goods & services from france will become cheaper for U.S residents and as a result the demand for french goods including french wine will increase.

Note: This question is about impact on exports or Imports due to Depriciation or Appreciation of domestic Currency(Dollar) in terms of Foreign Currency (Euro).