When a nations exchange rate depreciates
Answer: (d) Imported goods become more expensive in the local currency.
Answer: Option (d)
When the 'exchange rate' is quoted on the nightly finance report, it is the nominal exchange rate that is being referred to.
The nominal exchange rate is the number of units of one currency that can be purchased with one unit of another currency. It can be quoted in two different ways.
Consider the relationship between the Australian dollar ($A) and the United States dollar ($US).
First, how many $As are necessary to purchase one unit of the US currency ($US1)?
In this case, the $US is the reference currency, and the other currency is expressed in terms of how much of it is required to buy one unit of the reference currency. So $A1.25 = $US1 means that it takes $1.25 of Australian currency to buy one $US.
Second, if the $A is the reference currency, then we are asking how many US dollars are needed to buy one unit of Australian currency ($A1).
So, in the example above, this is written as $US0.80 = $A1.
Thus, if it takes $A1.25 to buy one $US, then $US0.80 is required to buy one $A.
The second quotation convention is typically used by the media.
A depreciation of the $A (as the reference currency) leads to:
1. Foreign goods becoming more expensive in terms of their $A price, which should lead to a fall in the quantity of imports demanded, if nothing else changes.
2. The price that foreigners must pay in their currency for Australian goods falls, which should lead to a rise in the quantity of exports demanded, if nothing else changes.
An appreciation of the $A leads to:
1. Cheaper foreign goods in terms of their $A price, which should lead to a rise in the quantity of imports demanded, if nothing else changes.
2. Foreigners having to pay higher prices, for a given $A price for Australian-produced goods. This should lead to a fall in the quantity of exports demanded, if nothing else changes.