Economics Q- Exchange rates (1 Viewer)

[ishanik]

In the Dixon workbook the questions said " explain the impact of a depreciation of the $AUD on the BOP"

In their response they said this:

A depreciation of the Australian dollar has mixed impacts upon the different components of
the balance of payments over time. In the short term, a depreciation would increase the
Australian dollar price of imports, increasing import expenditure and worsening the balance on
goods and services.

Shouldn't import expenditure go down, since its more expensive to purchase imports?

 

[Traveller0901]

As the aus $ depreciates, exports due to increase in domestic aggregate demand ,thus increasing households n businesses discretionary income and therefore they may choose to buy imported goods. Therefore deteriorating the economy's Bop and Cad

 

[deswa1]

The key phrase in that is in the short term.

Considering that in the short term, imports are relatively inelastic, if the $AUD goes down, we have to pay more for any given resource, and hence import expenditure goes up. Let's say if Australia needed 100,000 tonnes of steel- if the AUD goes down (hence imported steel goes up), in the short run we can't suddenly start producing more steel in Australia so we have to just buy the 100,000 tonnes at the higher price. This is a price effect.

In the long run, this constraint is removed. As the AUD goes down, imports become less competitive, so we import less in the long run. This is a volume effect.

 

[ishanik]

The key phrase in that is in the short term.

Considering that in the short term, imports are relatively inelastic, if the $AUD goes down, we have to pay more for any given resource, and hence import expenditure goes up. Let's say if Australia needed 100,000 tonnes of steel- if the AUD goes down (hence imported steel goes up), in the short run we can't suddenly start producing more steel in Australia so we have to just buy the 100,000 tonnes at the higher price. This is a price effect.

In the long run, this constraint is removed. As the AUD goes down, imports become less competitive, so we import less in the long run. This is a volume effect.

but wouldnt exports become cheaper? hence an increase in export revenue?

 

[deswa1]

but wouldnt exports become cheaper? hence an increase in export revenue?

Again, remember the distinction between short term and long term. I'll answer about imports given that's what the original question was about and then its just the reverse for exports.

When the AUD goes down, imports become more expensive. Originally, if a car cost $100 USD (at AUD:USD=1:1), then it costs $100 AUD. If the dollar depreciates to AUD:USD=0.5:1, then that same car now costs $200.

Now for the difference between short term and long term. Forget about countries, exports etc. Think about a shop.

Let's say you sell computers at $1000 and you are a major supplier of a company.

Short Term:

You increase your costs to $2000. People don't have time to find a new supplier. They still buy from you at $2000, so total expenditure has gone up.

Long Term:

People start realising that the higher price is a scam. They now have time for a new supplier. They no longer buy from you at $2000, so total expenditure goes down.

This is what is called the J-Curve in economics. In the short run, in a depreciation, exports become cheaper and imports more expensive, and nobody changes the quantity of what you buy, so the BOGS declines. In the long run, people start buying more of our exports, and we import less, so BOGS improves.

Does this make sense?

 

[ishanik]

Oh thats makes sense deswa1. So its all about time lag e.g. short term and long term!

Thank you for your help!