Cambridge International as and a level Economics Ebook

The eff ects of changing foreign exchange 
rates on the domestic economy and external 
economy
A depreciation/devaluation
A fall in the value of the exchange rate will make exports 
cheaper, in terms of foreign currencies, and imports more 
expensive, in terms of the domestic currency. Th
is may 
enable domestic fi rms to sell more products both at home 
and abroad. Some domestic consumers may now purchase 
home-made products rather than the now relatively more 
expensive imports. Some foreigners may now buy the 
country’s exports rather than products produced by fi rms 
in other countries.
A rise in net exports will increase aggregate demand. 
As can be seen in
 Figure 4.16
, this may result in in 
a rise in output. Higher output may result in lower 
unemployment.
As the 
Figure 4.16
 shows, the higher aggregate 
demand that occurs because of a rise in net exports 
may also give rise to infl ationary pressure. As the 
economy approaches full capacity, resources will become 
increasingly scarce and their prices will be bid up. 
In addition, fi nished imported products that are still 
purchased will be more expensive and some of these 
will count in the country’s consumer price index. Costs 
of production will be pushed up because the cost of 
SELF-ASSESSMENT TASK 
4.7
Th
e Chinese currency, the renminbi, is allowed to 
change by 1% a day on either side of a rate set each 
morning by the central bank. In 2013 its nominal 
rate rose against both the US dollar and the Japanese 
yen and its real exchange rate rose even more. Its 
nominal foreign exchange rate rose, in part, because 
of a higher interest rate in the country than in the US 
and Japan.
Among the causes of the long-term increase in 
China’s real exchange rate are the country’s rapid 
economic growth and an increasing shortage of 
workers.