Instructor’s Manual
CHAPTER 14
EXCHANGE-RATE ADJUSTMENTS AND THE BALANCE OF PAYMENTS
CHAPTER OVERVIEW
This chapter considers exchange-rate adjustments and the balance of payments. The chapter notes that currency
depreciation (devaluation) can affect a nation’s trade position through its impact on relative prices, incomes, and
purchasing power of money balances.
The chapter first considers the situation where all of a firm’s inputs are acquired domestically and their costs are
denominated in the domestic currency. As a result, an appreciation in the domestic currency’s exchange value
increases a firm’s costs by the same proportion, in terms of the foreign currency.
Next, the chapter considers the situation where manufacturers obtain inputs from abroad whose costs are
denominated in terms of a foreign currency. As foreign-currency-denominated costs become a larger portion of a
After completing the chapter, students should be able to:
• Discuss how currency depreciation (devaluation) affects a nation’s trade position through its impact on relative
prices, incomes, and purchasing power of money balances.
BRIEF ANSWERS TO STUDY QUESTIONS
Instructor’s Manual
1. Currency devaluation affects a country’s trade balance via its impact on relative prices (elasticities approach),
2. See Question 1.
3. The Marshall-Lerner condition refers to the elasticities approach to devaluation. It suggests that devaluation
4. The J-curve effect implies that due to time lags between the response of goods traded to relative price
5. The extent to which changing currency values lead to changes in import and export prices is known as the
7. The monetary approach suggests currency devaluation affects the domestic price level and the purchasing
power of money balances, which lead to changes in domestic expenditures and the level of imports.
9. The 50 percent dollar appreciation results in a less-than 50 percent increase in the firm’s production cost in
terms of the peso.
10. a. Export quantity 1000
Instructor’s Manual
Export price $3000
Export receipts $3 million
b. The dollar depreciation improves (worsens) the U.S. trade balance when the sum of the export–
demand elasticity and the import-demand elasticity are greater (less) than 1.0.
c. Because the sum of the export-demand elasticity and the import-demand elasticity are less than