Question

if inflation raises u.s. prices by 2 percent and the u.s. dollar appreciates by 3 percent, by how much does the foreign price of u.s. exports change?

Answer 1

The foreign price of U.S. exports changes by a net amount of 1 percent decrease due to a 2 percent inflation being counteracted by a 3 percent appreciation of the U.S. dollar.

Step-by-step explanation:

If inflation raises U.S. prices by 2 percent and the U.S. dollar appreciates by 3 percent, there are two effects that combine to determine how much the foreign price of U.S. exports will change. First, with a 2 percent inflation, the price of goods in the U.S. has increased, meaning that without any change in the exchange rate, U.S. exports would be 2 percent more expensive for foreigners. However, the fact that the U.S. dollar has appreciated by 3 percent counteracts this because it makes U.S. goods less expensive in terms of foreign currency.

Here's how it works: The appreciation of the dollar by 3 percent effectively reduces the foreign currency price of U.S. goods by 3 percent. When these two percentages are combined, the net effect of a 2 percent increase in U.S. prices and a 3 percent appreciation of the dollar is a 1 percent decrease in the price of U.S. exports in terms of foreign currency. So, the foreign price of U.S. exports essentially changes by 1 percent, becoming cheaper rather than more expensive for foreign buyers due to the stronger dollar counteracting the impact of inflation.

Answer 2

The foreign price of U.S. exports changes due to a combination of 2% inflation, which increases prices, and a 3% appreciation of the dollar, which partially offsets the inflation. The net effect is an increase in the foreign price, but less than the inflation rate.

Step-by-step explanation:

When considering the effect of inflation and currency appreciation on the foreign price of U.S. exports, two factors must be taken into account: the domestic price change due to inflation, and the change in exchange rate due to the dollar's appreciation. In the given scenario, U.S. prices have inflated by 2%, which would naturally increase the cost of exports. However, the U.S. dollar has appreciated by 3%, which makes the dollar stronger against foreign currencies.

To calculate the net effect on the foreign price of U.S. exports, we'll use the example of a Ford pickup truck that costs $25,000. If the price in the U.S. increases by 2% due to inflation, the new price would be $25,500. Now, applying the 3% appreciation of the dollar, we need to adjust the exchange rate. If the original exchange rate was $1.30 per British pound, a 3% appreciation would make the new exchange rate $1.30 minus 3% of $1.30, which is approximately $1.26 per British pound. Therefore, the new price in British pounds would be $25,500 / $1.26 per British pound, or approximately £20,238.

In summary, the 2% inflation increases the price, but the 3% appreciation of the dollar partially offsets this increase on the foreign market. Consequently, the foreign price of U.S. exports would increase, but by a smaller percentage than the inflation rate, due to the appreciation of the dollar.