impact of depreciating currency (3)

Question 1

microeconomic impact of a depreciating currency on the UK economy

Answer 1

• importing industries -> increased cost of production (as imports are more expensive) -> reduced profits -> loss of dynamic efficiency r.g. railway industry as they import raw materials e.g. steel, fuel + vehicles
  exporting industries -> they BENEFIT since exports are cheaper to foreginers -> increased price competitiveness -> increased sales revenue -> increased profits -> more funds for investments (continue chain) e.g. tourism
• consumers -> may face higher prices for imported goods (e.g. fuel, food [40% of food in the UK is imported] -> may face higher cost of living -> reduced consumer welfare + purchasing power -> consumer surplus decreased
• if from exporting indsutry -> consumers benefit from lower prices (vice versa from previous point)

Question 2

evaluate the microeconomic impact of a depreciating currency on the UK economy

Answer 2

1. importing industries -> they can engage in forward markets -> prevents price fluctuations of production inputs -> cost of production does not increase
   - depends of PED/level of competition within the industry -> if price inelastic, firms can pass on their higher costs = higher prices for consumers as they are less price sensitive
   - importing indsutries can switch to cheaper alternatives from domestic producers (‘import substitutes’) -> increases sales for domestic producers -> protects their businesses
   2, exporting industries -> depends on PED; UK isn’t known for its tourism so is not the biggest source of export revenue

Question 3

macroeconomic impact of a depreciating currency on the UK economy

Answer 3

ACTUAL ECO. GROWTH + IMPROVED BOP
- depreciation = exports cheap for foreigners, imports expensive for UK citizens -> exports more price competitive -> E>I (increased export revenue + improved current account deficit) -> net exports increased (1% of AD in UK) -> AD rise -> real GDP rise -> export = injection -> +ve multiplier -> domestic businesses expand to meet incr demand -> incr DFL -> reduced cyclical unemployment -> workers have a source of income -> more consumption (60% of AD in UK) -> further incr in AD (AD2->AD3) -> further incr in real GDP -> reduction in -ve output gap -> actual eco. growth

Question 4

evaluate the macroeconomic impact of a depreciating currency on the UK economy

Answer 4

• net exports = small component of AD -> no significant incr in AD
• trade off (Phillips Curve) - if UK operating near full capacity -> risk of demand-pull inflation -> erodes purchasing power
• J-curve - SR - current account may worsen before improving in LR
• MLC - currency depreciation leads to improved current account ONLY IF PED of exports + imports > 1. imports may = inelastic (give reason) (e.g. 40% of food in the UK is imported) -> PED of imports < 1 -> MLC not satisfied -> current account not improved