International Finance

OPERATING EXPOSUREpre-devaluation level, D 1 , a volume X 1 can be soldat the exporter’s currency (dollar) price p $ 1 . Afterthe devaluation, the same quantity – that is, X 1 –will be sold abroad if the foreign-currency price isstill the same as other suppliers. Sales depend onthe price buyer’s faces, and if Aviva keeps its poundprice in line with the prices charged by other suppliersto the British market it will remain competitive.This is because the British do not look at theprice tag of a pair of US-made jeans on sale in Britainin terms of the US dollar. Rather, they consider thenumber of pounds that must be paid for the jeans,just as a US car buyer considers the dollar price of animported car. But at the devalued exchange rate ofthe dollar the unchanged pound price means ahigher dollar price. Indeed, the dollar price is higherby the percent of dollar devaluation. In otherwords, if the dollar price changes by the amount ofdevaluation from p $ 1 to p$ 2 in Figure 11.3, then saleswill remain unchanged at X l . That is, before thedevaluation at price p $ 1 Aviva will sell X l abroad andhence be at point A. After the devaluation, Avivawill sell the same amount, X l , abroad if the dollarprice is p $ 2 ¼½S0 ($/£)/S($/£)Šp $ 1 . This gives pointB. We find that the percent vertical shift of thedemand curve is equal to the percent of devaluation.We can now take another sales volume, say X 2 ,and follow precisely the same argument. Eachand every point on the new demand curve, D 2 , willbe vertically above the old demand curve, D l ,inproportion to the devaluation.We should think in terms of vertical movementsof the demand curve, rather than think of ‘‘rightwardshifts’’ of the demand curve along the linesthat ‘‘more is sold for the same dollar price afterdevaluation.’’ Although this is true, it does not tellus how much the demand curve shifts, whereas weknow the vertical shift is in the same proportionas the change in the exchange rate. Of course, wenotice that since the vertical shift is always in thesame proportion as the change in exchange rate,the absolute shift is less at lower prices on thedemand curve. This is shown in Figure 11.3, withdemand curve D 2 closer to D 1 at lower prices.Price, cost in home currency ($)p $ 2p $ 1ABCAMR 2MR 1D 2D 1MCPrice, cost in home currency ($)MR 1MR2MCOX 1 X 2O X 1 X 2Exports per period of time(a) RevenuesExports per period of time(b) Costs& Figure 11.4 Exporter and devaluation in an imperfectly competitive marketNotesIn an imperfectly competitive market the home-currency price of exports will increase by a smaller percentage thanthe devaluation. Sales revenue will increase by a smaller fraction than in the case of perfect competition.237 &