Question

G11-2 Exchange Rate Effects on Your Firm Describe how a change in the exchange rate affected your firm. Explain what happened to your price and quantity. How can you profit from future shifts in the exchange rate? How do you predict future changes in the exchange rate?

Answer 1

Exchange rate is the value of one currency in exchange of other. Assume you import raw material from any other nation or sell your products abroad. If there is depreciation in exchange rate which makes domestic currency comparatively cheaper to foreign currency. People abroad will find domestically produced goods cheaper because they have to pay less of their currency to buy same of domestic currency. It will result in rise in exports of domestic nation. On the other hand, depreciation of domestic currency will make foreign currency comparatively costly so that you have to pay more in foreign currency to buy same raw material you used to purchase before.

If we take the case of rise in net exports due to depreciation of domestic currency, aggregate demand of domestic will shift to its right which will raise price level as well as quantity sold in domestic economy as depicted in diagram below.

Continue taking the case when you import raw material from abroad. Appreciation of foreign currency let say after 6 months will raise cost of rw material. If you predict rise in exchange rate and stock raw material for one year now when exchange rate is stable, you can make profit.

Exchange rate can be predicted through:

• Interest rate in both countries
• Inflation rate in both countries
• Government policies adopted