Question

Explain the effects of an increase in the value of the domestic currency on a firm’s revenues under each of the following conditions:

a) The firm sells only domestically

b) The firm purchases supplies from other countries

c) The firm sells products domestically and in other countries

d) The firm has manafacturing plants located in other countries

Answer 1

Increase in value of domestic currency is termed as currency appreciation . Now let us first see the effects of currency appreciation . It makes cheaper to buy foreign currency with which to pay for foreign goods, leading to more demand for foreign goods . So it puts a downward pressure on the home aggregate price level as the imports in the market basket, used for calculating the price level, becomes cheaper . In contrast, purchases of home country goods by foreigners become more expensive since the home country currency has become more expensive to obtain so exports will fall .

a) Firms selling only domestically experiences fall in revenue because imported goods have become cheaper leading to fall in aggregate price .

b) The revenue of such a firm rises . Since goods purchased from other countries is cheaper now . So input costs falls and the revenue rises .

c) This firm also faces fall in revenue because of fall in domestic price level and also due to fall in demand for exports .

d) The revenue increases since other county's currency has depreciated leading to higher domestic price level in those countries .