The exchange rate is the value of one currency for the purpose of conversion to another. When there is a fall in the exchange rate, it is a depreciation of the pound, meaning the pound is worth less in comparison to other currencies e.g ‘Pound has fallen by over 5% against the US dollar during the past month’
As imports and exports effect imports and exports, there would be a change in AD and the balance of payments equilibrium (to do with trade). A depreciation of the exchange rate has on the relative prices of exports and imports imports would become more expensive (as the pound is worth less in comparison to other currencies) and exports would become less expensive which means British exports are now more price competitive e.g ‘A recession in the eurozone economies will reduce UK exports and lead to lower economic activity in the UK’. However, it also means that, if, for any reason (e.g non-price elastic goods), demand does not increase, Britain would gain less from exporting and GDP would fall. Demand for exports would rise, assuming they are price elastic so AD would rise.
A fall in the change rate would have a severe impact on the balance of payments which impacts upon economic growth as growth is impeded by a shift in the balance of payments as trade is affected global economies must the change and adapt which takes time. Changes in demand for exports and imports should lead to improvements on the current account, therefore, current account deficit reduces which shows economic long term growth. However, this assumes goods are price elastic, which they may not be as imports and exports are not always price elastic as many are necessities.
Many imported products are necessities such as raw materials or oil which are needed for almost all aspects of everyday living. In the short run factors which prevent demand from changing for example, contracts, asymmetric information (takes time for consumers to find out about price changes and respond), assumes that imports and exports have perfect substitutes which is untrue with such products as raw materials.
In the long run, imports and exports are limey to become more elastic as consumers and firms are more likely to be able to change their behaviour. For example, greater access to information could lead to a higher impact on the balance of power which may be more significant in the long run. For example, Britain would be less likely to be reliant on imports so there is a higher chance of reducing the deficit.
Changes in imports and exports also affect economic growth, employment and price stability. Lower imports and higher exports mean that there is an increase in which means that AD rises. This creates a positive multipliers as, then, Britain would be able to import more (see diagram).…