Question

Elaborate on the following statement: A rise in the British pound price of US dollars necessarily implies a fall in the dollar price of pounds. Which currency has appreciated? Which has depreciated? What trade factors, according to Hume, might cause this change in the relative value of the two currencies? How might a the change in the exchange rate eventually correct the situation?

Answer 1

Ans. A rise in British pound price of US dollars means that now US has to pay more dollars in order to buy one pound, which means that pound is appreciated and as There is a fall in dollars price of pounds means that buying dollars has become more cheaper means that dollar is depreciated.

The reason for the relative change in the two currencies is the Us current account deficit, as US imports is more than its export it means US needs more pounds to pay for its excess imports, for this purpose US demand for pounds has increased, and the excess demand for the British pounds lowers the US exchange rate untill US goods and services is cheaper enough to fulfill the demand of Britishers.

As there is change in the exchange rate, Dollar depreciated and pound appreciated, due to the depreciation of US dollars, the US product seems to be cheaper to the British, so their demand for US products has increased which leads to the correction of US current account deficit problem.