Final Exam Questions

Assume that the United States exports 1,000 computers costing $3,000 each and imports 150 UK autos at a price of £10,000 each. Assume that the dollar/pound exchange rate is $2 per pound.

Exchange rate: £1 = $2

$1 = £0.50

Calculate in dollar terms:

The US export receipt

$3000 * 1000 laptops = $3,000,000 in American dollars

$3,000,000 * £.0.50 = £1,500,000

1.5 million pounds

US import payments

£10,000 * 150 autos = £1,500,000 in British pounds

£1,500,000 * $2 = $3,000,000

3 million dollars

Trade balance

Balance of trade = Value of Exports - Value of Imports

$3,000,000 - $3,000,000 = 0

Suppose the dollar’s exchange value depreciates by 10%. Assuming that the price elasticity of demand for exports for the U.S. equals 3, any price elasticity of demand for US imports equals 2, does the dollar depreciation improve or worsen the US trade balance? Why?

The Marshall-Lerner condition states that a currency devaluation will only lead to an improvement in the balance of payments if the sum of demand elasticity for imports and exports is greater than one. It means the reverse of this statement will also be true that if the sum of export demand elasticity and import demand elasticity is less than one, then the trade balance will worsen. In the question, the export demand elasticity is 3 and import demand elasticity is 2, which means the sum of export demand elasticity and import demand elasticity is 5 which is greater than one. It means the trade balance will improve.

Now assume that the price elasticity of demand for US exports equals 0.3 and price elasticity of demand for US imports equals 0.2. Does this change the outcome? Why?

Yes, this completely alters the outcome. As it has been stated, dollar depreciation improves trade balance if the sum of export demand elasticity and import demand elasticity is greater than one. In this question, the export demand elasticity is 0.3 and import demand elasticity is 0.2, which means the sum of export demand elasticity and import demand elasticity is 0.5 which is less than one. This means the trade balance will worsen.