Slide 1Effects of Exchange-Rate Changes on Costs and PricesSlide 3Effects of Exchange-Rate Changes on Costs and PricesSlide 5Effects of Exchange-Rate Changes on Costs and PricesEffects of Exchange-Rate Changes on Costs and PricesEffects of Exchange-Rate Changes on Costs and PricesEffects of Exchange-Rate Changes on Costs and PricesEffects of Exchange-Rate Changes on Costs and PricesSlide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23J-Curve Effect: Time Path of DepreciationJ-Curve Effect: Time Path of DepreciationJ-Curve Effect: Time Path of DepreciationDepreciation flowchartSlide 28Exchange Rate Pass-ThroughExchange Rate Pass-ThroughExchange rate pass-through into import prices after one yearExchange Rate Pass-ThroughSlide 33Exchange Rate Pass-ThroughExchange Rate Pass-ThroughWhy a dollar depreciation may not close the U.S. trade deficitWhy a dollar depreciation may not close the U.S. trade deficitThe Absorption Approach to Currency DepreciationThe Absorption Approach to Currency DepreciationThe Absorption Approach to Currency DepreciationThe Absorption Approach to Currency DepreciationThe Absorption Approach to Currency DepreciationThe Absorption Approach to Currency DepreciationThe Monetary Approach to Currency DepreciationThe Monetary Approach to Currency DepreciationExchange-Rate Adjustmentsand the Balance of Payments© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password protected website for classroom use‐1PowerPoint slides prepared by:Andreea ChiritescuEastern Illinois UniversityEffects of Exchange-Rate Changes on Costs and Prices•How do exchange-rate fluctuations affect relative costs?•Extent to which a firm’s costs are denominated in terms of the home currency or foreign currency•No foreign sourcing - all costs are denominated in dollars•If the dollar appreciates by 100%, the U.S. firm:•Increase in franc-denominated production costs by 100% - Reduced international competitiveness© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password protected website for classroom use‐2© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password protected website for classroom use‐3Effects of a dollar appreciation on a U.S. steel firm’s production costs when all costs are dollar-denominatedTABLE 14.1Effects of Exchange-Rate Changes on Costs and Prices•Foreign sourcing—some costs denominated in dollars and some costs denominated in francs•If the dollar appreciates by 100%, the U.S. firm:•Production costs in francs increase by 100% for the inputs denominated in dollars•Production costs in francs stay the same for the inputs denominated in francs •Overall, higher production costs (by less than 100%)•Reduced international competitiveness© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password protected website for classroom use‐4© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password protected website for classroom use‐5Effects of a dollar appreciation on a U.S. steel firm’s production costs when some costs are dollar-denominated and other costs are franc-denominatedTABLE 14.2Effects of Exchange-Rate Changes on Costs and Prices•Generalization •As franc-denominated costs become a larger portion of Nucor’s total costs•A dollar appreciation (depreciation) leads to•A smaller increase (decrease) in the franc cost of Nucor steel •A larger decrease (increase) in the dollar cost of Nucor steel compared to the cost changes that occur when all input costs are dollar-denominated© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password protected website for classroom use‐6Effects of Exchange-Rate Changes on Costs and Prices•Changes in relative costs •Because of exchange-rate fluctuations •Influence relative prices •Influence the volume of goods traded among nations© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password protected website for classroom use‐7Effects of Exchange-Rate Changes on Costs and Prices•Dollar appreciation•Increasing relative U.S. production costs•Raise U.S. export prices in foreign-currency terms•Decrease in the quantity of U.S. goods sold abroad•Increase in U.S. imports© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password protected website for classroom use‐8Effects of Exchange-Rate Changes on Costs and Prices•Dollar depreciation•Decreasing relative U.S. production costs•Lower U.S. export prices in foreign-currency terms•Increase in the quantity of U.S. goods sold abroad•Decrease in U.S. imports© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password protected website for classroom use‐9Effects of Exchange-Rate Changes on Costs and Prices•Factors influencing the extent by which exchange-rate movements lead to relative price changes among nations•U.S. exporters – reduce profit margins to maintain competitiveness•Perceptions concerning long-term trends in exchange rates - promote price rigidity•Product substitutability•Move production offshore©