I recently heard on a video that when the value of the currency of an economy rises, it is less desirable to trade with that economy. I couldn't understand it.
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3 Answers
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To buy something in a foreign country you first have to obtain the foreign currency. Generally speaking you can't buy goods and services in US with euros and EU with dollars.
When currency in country X appreciates it is more expensive for foreigners to buy that currency (which they need to buy goods and services). So when currency appreciates foreigners will find it less desirable to trade with the country X because from their point of view everything suddenly becomes much more expensive).
answered Nov 20, 2022 at 12:07
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$\begingroup$ I would remove the last "much" because we are not told the shift in exchange rates is large, but otherwise I think this is the best answer based on the question. $\endgroup$ Commented Nov 21, 2022 at 2:55
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In 101 macro, there are two concepts regarding exchange rates:
- Nominal exchange rate $(e)$:
The exchange rate we all hear about (how many units of local currency you have to give up for one unit of foreign currency)
- Real exchange rate $(\epsilon)$:
How many units of a local good you would give up by buying one unit of a foreign good.
It is easy to check that the formula is:
$\epsilon = e \cdot \frac{P^*}{P}$,
where
$P^* =$ price of the good in the foreign country,
$P = $ local price if the good.
If the value of a foreign currency increases, then $e$ increases. Keeping prices constant, $\epsilon$ increases proportionally.
This implies that buying a foreign good now has a higher opportunity cost in terms of the local goods you could rather buy. This would decrease demand of that foreign country’s goods.
Therefore, a revaluation of a country’s currency comes together with a decrease in its exports $(X)$.
It would also generate an increase in its imports $(I)$ as that country would perceive other countries’ goods as cheaper, meaning they would demand more of them.
The general effect of country’s currency revaluation is that their net exports $(NX)$:
$NX = X - I$
go down.
answered Nov 20, 2022 at 14:36
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The statement in that video is incorrect, or rather incomplete.
If the value of the currency of an economy rises it becomes less attractive to buy from this economy. Because it's products are now more expensive for other countries/economies.
However on the flip side, if the value of the currency of this economy rises it's more attractive to sell to them. Because the money/currency you receive for your products is more valuable now.
