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Q: Exchange Rate's effect on imports and exports. ( Answered ,   1 Comment )
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 Subject: Exchange Rate's effect on imports and exports. Category: Business and Money > Economics Asked by: hakbeeb_the_dweeb-ga List Price: \$20.00 Posted: 22 Feb 2004 20:36 PST Expires: 23 Mar 2004 20:36 PST Question ID: 309699
 ```How do exchange rates effect imports and exports? In my mind, if the exchange rate between country A and country B is \$1(A) for every \$10(B) (or country A's currency is 10 times more valuable than country B's currency), then a hamburger in country A which sells for \$1(A) will sell for \$10(B) in country B (realizing that this is an overly simplified example). So if I live in country B and I want to buy a hamburger from country A, I will first spend \$10(B) to receive \$1(A). Then I will buy the burger from country A for the \$1(A). Either place I buy the burger from, it's going to cost me \$10(B). Where is the flaw in my thinking. My question is in reference to the fact that some (if not all) Asian nations are trying to keep their currencies week with respect to the dollar in order to encourage exports to the US.```
 ```Hi, I don't know if I'd call it a flaw in your thinking, but what you say is true as far as it goes. But the results are different if you make different assumptions. For the sake of simplicity here, I'm going to talk about dollars and pesos and say that one dollar equals 10 pesos. It's easier for me to keep track of things that way. In your example, you say that a hamburger that sells for \$1 in one country sells for 10 pesos in the other country. If that is the case, you're right that it doesn't matter where you buy the hamburger. But let's say that a hamburger costs \$1 dollar in the first country and only 5 pesos in the other country. Then you could go to the poorer country and use the same dollar to buy two hamburgers instead of one. So all other things being equal, the trend would be for hamburgers to be exported from the peso country and imported into the dollar country. So we might say that the price of the hamburger is less in pesos than it is in dollars. In this case, we'd say that the dollar is stronger than the peso, or that the peso is weaker than the dollar. (Of course, I'm oversimplifying things quite a bit, since hamburgers aren't the only trading item.) It's interesting that you mention hamburgers. There's a commonly used index developed by the Economist magazine that compares the cost of Big Mac hamburgers (the kind from McDonald's) from country to country as a fun-but-serious exercise to see how much currencies are really worth. You can see the hamburger index on this page: The Hamburger Standard http://www.oanda.com/products/bigmac/bigmac.shtml If you look at this chart, you can see that there is a wide variation in what a Big Mac hamburger costs in U.S. dollars, ranging from \$1.20 in China to \$2.65 in the United States to \$5.04 in Sweden. (In real life, of course, exchange rates and such aren't the only things affecting prices. Taxes in Europe can make prices there higher even if their currencies aren't particularly weak.) Another way of explaining this chart is to say that the dollar is worth more in China than in the U.S., but worth less in Switzerland than in the U.S. (Again, this is assuming that the hamburger is the only commodity, which it is not.) So if hamburgers could be shipped across the oceans and there were no import/export taxes, it would make sense for everyone to buy their hamburgers from China. Let's go back to the original example, where 10 pesos equals a dollar and where you can buy a hamburger in the dollar country for a dollar but in the peso country for the equivalent of half a dollar. As you can see, this disparity in the buying power of the currencies would mean lots of hamburgers leaving the peso country and going to the dollar country. Suppose the dollar country doesn't like this. One thing it could do is weaken its currency. Suppose the exchange rate changes to 5 pesos per dollar. Then all of a sudden the peso-valued hamburgers will cost the same in either country. Let me give a personal example that shows a little bit of how this works. I'm a U.S. resident. A few summers ago I vacationed in Canada when the exchange rate was about \$1.55 Canadian = \$1 U.S. Things seemed really cheap for me. I remember taking a family of five to a restaurant and all of us eating for \$30 Canadian, which then was about \$19.35 U.S. Nowadays, though, the Canadian exchange rate is \$1.33 Canadian to \$1 U.S., so the same meal would cost the equivalent of \$22.56 U.S. That's still not bad, but it does make Canada less attractive as a vacation destination. I'd also point out that I live fairly close to the Canadian border. When the exchange rate was high for Canadians, there were very few Canadians shopping in the stores near where I live. But now, shopping by Canadian customers has increased over what it was (but it's still less than it was when the exchange rate was \$1.15 Canadian to \$1 U.S.). Something similar is happening now for U.S. residents traveling in Europe. Prices there are high for Americans, so fewer are traveling there. But the U.S. is more of a bargain for Europeans, so more are coming here. The prices are more or less the same in dollars as they have always been (except for a small amount of inflation), and the prices in euros are the more or less the same they have always been, but the changing exchange rates changes the prices for those using a foreign currency. To get back to your question, the reason some Asian countries want a weak currency is so they can sell more products. With a weak Asian currency, the price for Americans (for example) buying is less. (On the other hand, imports into those Asian countries are priced higher.) By undervaluing their currency, they can export more. Here are some resources that explain this, maybe better than I have. A Beginner's Guide to Exchange Rates and the Foreign Exchange Market This is an eight-part explanation of exchange rates. Despite the title, not all of it is at the beginner's level. The most useful section for answering your question is the second part. http://economics.about.com/cs/money/l/aa022703a.htm How Exchange Rates Work This site provides an understandable explanation of exchange rates. http://money.howstuffworks.com/exchange-rate.htm The Effect of Exchange Rates This page has some graphs to help explain. http://www.revisionguru.co.uk/economics/exports.htm Briefing Note This brief technical paper explains the affect of exchange rates on the Lithuanian economy. http://www.cid.harvard.edu/caer2/htm/content/papers/bns/dp10bn.htm Foreign Trade and Foreign Debt This notes for a college-level class explain in influence of exchange rates not only on imports/exports, but also on national debt and other items of interest to economists. http://fazz.wustl.edu/econ104/lec-031015.doc The Euro -- Cause for Concern? This article explains not only why a weak euro can lead to more exports from Europe, but also what negative consequences a weaker euro can have. http://www.hwwa.de/Publications/Intereconomics/1999/ie_docs1999/ie9904-scharrer.htm I hope my answer and these additional documents fully answer your question. Sincerely, Mvguy-ga Google searches used: site:howstuffworks.com "foreign exchange" ://www.google.com/search?hl=es&ie=UTF-8&oe=utf-8&q=site%3Ahowstuffworks.com+%22foreign+exchange%22 economist "big mac" ://www.google.com/search?q=economist+%22big+mac%22 "exchange rates" "affect exports" ://www.google.com/search?hl=es&ie=UTF-8&oe=utf-8&q=%22exchange+rates%22+%22affect+exports%22 I also searched for the word "exchange" in this page: Economics - The A to Z List http://economics.about.com/library/weekly/bl-a-to-z.htm``` Request for Answer Clarification by hakbeeb_the_dweeb-ga on 23 Feb 2004 04:31 PST ```So briefly, a change in exchange rates between two countries does not directly translate into changes in prices within the respective countries? In other words, from your example, the hamburger costs 5 pesos (presumably in Mexico) before the change in exchange rates, and the hamburger still costs 5 pesos (factoring out inflation/ supply-demand etc.) after the change in exchange rates? That sounds like the key.``` Clarification of Answer by mvguy-ga on 23 Feb 2004 09:36 PST ```That's correct. To use one example I gave, the meal that cost me \$30 Canadian in Canada three years ago still costs \$30 Canadian. (Actually, it probably has gone up a bit due to inflation, but the U.S. and Canadian inflation rates are about the same, so that factor balances out.) So its price has gone up for me, an American earning American dollars, but not for my Canadian friends. Of course, I have simplified things quite a bit, so you raise a good point. In the real world, the sellers in the peso country might try to raise prices because they don't have competition at their price, and the sellers in the dollar country might lower theirs to be more competitive. There also can be various pressures for a country to have a realistically valued currency. One of the pressures is international debt. Suppose the peso country has a large international debt that has to be paid in dollars; if it devalues its currency too much, it's not going to get enough dollars to pay its debts. This is one reason why some countries try to keep their currency high. So there are lots of factors that enter into the situation. Similarly, if a country's currency is too weak, there is little incentive for foreign investors to help develop businesses and that sort of thing. A weak currency can also lead to inflation, partly because imports become expensive. So things can get quite complicated as countries take steps to regulate the value of the currency. But the basic premise of the answer remains true, that as the currency of country A drops in value compared to other currencies, the tendency will be for its exports to increase. As its value of the country's currency increases, it will tend to import more and export less. So you're right that over the long term, assuming completely free markets (which we don't have) and lack of any government intervention into any economy, prices would tend to equalize everywhere. But in the short and medium term, currency price manipulation can be one way a country can increase its exports. Here are some articles that touch on this matter. They clearly indicates how countries do manipulate their currencies for trade reasons, but they also demonstrate that there are problems with doing so. The Dollar Debacle http://www.mises.org/freemarket_detail.asp?control=245&sortorder=authorlast Gold and the U.S. Elections http://www.kitco.com/ind/Resopp/feb032004.html U.S. - Japan Joint Devaluation Needed http://polyconomics.com/shownuff.asp?ArticleID=1328```
 hakbeeb_the_dweeb-ga rated this answer: and gave an additional tip of: \$5.00 ```Answered my question thoroughly, and plainly. Great examples, great links, nice work!```
 `Thanks for the compliments, the rating and the tip!`