Abeka Economic – Work And Prosperity Test 6 Practice

Depreciation of a country's currency: what is a likely effect on inflation and trade?

Imports become more expensive, exports more competitive, inflation may rise Inflation falls as currency devalues No effect on trade It always reduces unemployment

Correct Answer:

Imports become more expensive, exports more competitive, inflation may rise

Explanation:

When a country's currency depreciates, prices of imports rise in domestic currency, pushing up overall inflation. At the same time, a weaker currency makes domestically produced goods cheaper for foreign buyers, boosting demand for exports and improving the trade balance in the short run. So the likely effect is higher inflation alongside more competitive exports (and pricier imports). The idea that inflation would fall with devaluation isn’t consistent with higher import costs, and saying there’s no effect on trade ignores the clear shift in relative prices. The claim that unemployment must fall is not guaranteed, since employment outcomes depend on many interacting factors.

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