Assume that a country with a fixed exchange reate has an import of 100 per month

Question

Assume that a country with a fixed exchange reate has an import of 100 per month and an export of 100 per month. Suddenly and unexpectedly the exchange rate is devaluated with 10 percent. Calculate the change on net export due to the devaluation if we assume import contracts to be denoted in foreign currency and export contracts to be denoted in domestic currency, for the following three time periods.

A. The first month after the devaluation, assume all imports and exports during thi month was contracted before the devauation but that the payments are made after the devaluation.

B. The third month after the devaluation, assume all imports and exports in this period is contracted after the devaluation and that the price elasticity of imports is 0.4 and the price elasticity of export is 0.4

C. the tenth month after the devaluation. Assume all imports and exports in this period is contracted after the devaluation and that the price elasticity of imports is 1.5 and the price elasticity of export is 2

Explanation / Answer

In such a scenario the quantity exported and imported would remain constant as before devaluation but the payment would be affected which means that the devaluation would depreciate the money and for imports worth 100 we would pay 110 whereas for export worth 100 we would receive 90.

So the net exports will be :- Exports – Imports i.e 90 – 110 = -20 which shows a defecit

Since the price elasticity remains constant for both this shows that the change in import equals the change in exports which concludes that the net exports will remain constant.

Here the elasticity of export is more which means that the change in quantity will be 20 (since % change in export quantity / % change in price = elasticity of exports). In the similar way the change in quantity of imports will be 15. Thus the net exports will be 5

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