Question
Download Solution PDFHow can currency depreciation stimulate an increase in net exports?
1. By reducing export costs
2. By reducing import prices
Select the answer using the code given below:
This question was previously asked in
UPSC CDS-I 2025 (General Studies) Official Paper (Held On: 13 Apr, 2025)
Answer (Detailed Solution Below)
Option 1 : 1 only
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Detailed Solution
Download Solution PDFThe correct answer is Option 1.
Key Points
- Currency depreciation makes exports cheaper for foreign buyers, increasing demand for exported goods and services.
- Lower export costs improve competitiveness in international markets, driving up net exports.
- Depreciation increases the price of imports for domestic consumers, reducing import demand and further boosting net exports.
- Net exports (exports minus imports) tend to rise as a result of the combined effect of higher export volumes and reduced import volumes.
- This phenomenon is often referred to as the "exchange rate effect" on trade balances.
Additional Information
- Currency Depreciation: Refers to a decline in the value of a country's currency relative to foreign currencies, often influenced by market demand and supply dynamics.
- Impact on Trade Balance: Depreciation improves the trade balance by increasing exports and decreasing imports, provided that demand for goods is elastic.
- Elasticity of Demand: For currency depreciation to effectively impact net exports, the price elasticity of demand for exports and imports must be high (responsive to price changes).
- Marshall-Lerner Condition: States that currency depreciation will improve the trade balance if the sum of the absolute price elasticity of exports and imports is greater than one.
- Risk Factors: Excessive depreciation can lead to inflationary pressures and increased costs for imported raw materials, potentially offsetting export gains.
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