The Economic Effects of a Devaluation [ Biz/ed Virtual Developing Country ]

The Virtual Developing Country is a case study of Zambia. There are a series of field trips available looking at different issues connected with economic development. This tour is the trade tour, and this page looks at the effects of a devaluation in the currency on the economy.

Theories

The Economic Effects of a Devaluation

Next theory - The Imposition of Quotas >>

A fall in the exchange rate of a country's currency can occur due to market forces, where changes in the demand for or supply of a foreign currency change the equilibrium price. In the case of a fixed exchange rate the government can intervene in the foreign exchange market and cause a fall or devaluation in the exchange rate. In either case, the impact of a fall in the value of a currency will be the same.

As the value of a local currency such as the Kwacha depreciates, all Zambian exports become cheaper to overseas customers. The demand for the exports will increase. Export industries should see increases in their order books.

Conversely, the local prices of imports will increase causing domestic demand for these imported goods and services to fall. The conclusion might be drawn that the effect of cheaper exports and more expensive imports might improve the balance of payments situation. It is only possible to assess the impact on the balance of payments when the earnings from the exports and the spending on imports are considered. This will depend upon the price of the imports and exports AND the quantity of imports and exports bought and sold.

Students of economics will see that the price elasticity of demand for exports and imports plays an important part here. It is thus necessary to explore the conditions when a fall in the exchange rate will improve the balance of payments situation. This is embodied in the Marshall Lerner Condition.

Next theory - The Imposition of Quotas >>


Related Glossary Items:
Price Elasticity of Demand
Marshall-Lerner Condition
Devaluation
Fixed Exchange Rate
Floating Exchange rate
Balance of Payments

Related Issues:
Zambia's Exports and Imports
Zambia's Balance of Payments Situation

Related Theories:
Terms of Trade
Balance of Payments Policies
Exchange Rates:
Introduction to Exchange Rates
Fixed Exchange Rates
Floating Exchange Rates
Effects of a Floating Exchange Rate System
The Marshall-Lerner Condition
The Economic Effects of a Devaluation