Please answer this briefly. I won\'t rate if the answer seems like wrong or unsa
ID: 1185589 • Letter: P
Question
Please answer this briefly. I won't rate if the answer seems like wrong or unsatisfied. Assume the following to be true: Export contracts are denominated in domestic currency. Import contracts are denominated in foreign currency. Foreign exporters (the sellers of domestic imports) practice pricing to market while domestic exporters do not. What will happen to the domestic trade balance following a devaluation of the domestic currency? Explain carefully the effects during the pass-through period, and be sure to explain why these effects occur.Explanation / Answer
Real Exchange Rate is defined as the prices of foreign products relative to the prices of domestic products, both measured in domestic currency. => As the prices of foreign products rise relative to those of domestic products, expenditure on domestic products rises and expenditure on foreign products falls. ********* How Real Exchange Rate Changes Affect the Current Account ************** 1.) The current account measures the value of exports relative to the value of imports. a) When the real exchange rate rises, the prices of foreign products rise relative to the prices of domestic products. b) The volume of exports that are bought by foreigners rises. c) The volume of imports that are bought by domestic residents falls. d) The value of imports in terms of domestic products rises: the value/price of imports rises, since foreign products are more valuable/expensive. 2.) If the volumes of imports and exports do not change much, the value effect may dominate the volume effect when the real exchange rate changes. # for example: contract obligations to buy fixed amounts of products may cause the volume effect to be small. 3.) However, evidence indicates that for most countries the volume effect dominates the value effect in 1 year or less. 4.) Therefore, we assume that a real depreciation leads to an increase in the current account: the volume effect dominates the value effect. Summary: = With fixed domestic and foreign price levels, a rise in the nominal exchange rate makes foreign goods and services more expensive relative to domestic goods and services. = A rise in the exchange rate (a domestic currency depreciation) increases the aggregate demand for domestic products. " I hope the above answer fulfills your requirements. Feel Free to comment in case of any further assistance"