The Effect of Elasticity: Exports Elastic, Imports Inelastic
The Solution
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The rise in the price of exports by 5% will result in a fall in demand for exports by 1.6 x the rise in price (5%) = 8%.
This will lead to demand falling by 8% and will result in a fall in export revenue (the % change in demand is greater than the % change in price).
The price elasticity of demand for imports is inelastic (-0.3).
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The fall in the price of imports will lead to demand for imports rising by 0.3 times the fall in price (5%) = (1.5%) which in turn will lead to a fall in the expenditure on imports (the % change in demand is less than the % change in price).
It would be assumed that a fall in the price of imports would lead to a rise in demand, which does indeed happen, but that does not mean that exenditure on imports is going to rise as may be expected, causing problems for the balance of payments because of the value of the price elastiity of demand for imports.
As a result of both of these effects, the earnings on exports would fall but so would the expenditure on imports. The net effect on the balance of payments will depend on the relative size of the respective changes in export earnings and import expenditure.
