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SPECIALIZATION: The condition in which resources are primarily devoted to specific tasks. This is one of THE most important and most fundamental notions in the study of economics. Civilized human beings have long recognized that limited resources can be more effectively used in the production the goods and services that satisfy unlimited wants and needs if those resources specialize. For example, three ice cream parlor workers, can be, in total, more productive if one runs the cash register, another scoops the ice cream, and a third adds the hot fudge topping. By devoting their energies to learning how to do their respective tasks really, really well, these three workers can produce more hot fudge sundaes than if each performed all required tasks.

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EXCHANGE RATES, AGGREGATE EXPENDITURES DETERMINANT:

One of several specific aggregate expenditures determinants assumed constant when the aggregate expenditures line is constructed, and that shifts the aggregate expenditures line when it changes. An increase in the exchanges rates causes an increase (upward shift) of the aggregate expenditures line. A decrease in the exchanges rates causes a decrease (downward shift) of the aggregate expenditures line. Other notable aggregate expenditures determinants include consumer confidence, federal deficit, inflationary expectations, and interest rates.
An exchange rate is the price of one currency in terms of another, the rate at which one currency can be exchanged for another. For example, the exchange rate between U.S. dollars and British pounds is the price of buying one British pound in terms of the amount of U.S dollars paid.

An exchange rate of $2 per pound means that anyone buying one British pound pays a price of $2. Moreover, every nation has currency exchange rates between their domestic currency and other countries. The United States has exchange rates, not only with British pounds, but Japanese yen, French francs, Mexican pesos, Canadian dollars, and a whole lot more.

Exchange rates surface as an aggregate expenditures determinant because they effect the relative prices of imports and exports, and thus the net exports component of aggregate expenditures. When exchange rates change, the relative prices of exports and imports also change which causes exports, imports, net exports, and thus aggregate expenditures to change.

  • An increase in the exchange rate, that is, the price of buying foreign currency in terms of domestic currency increases, causes an increase in net exports and an increase in aggregate expenditures.

  • A decrease in the exchange rate, that is, the price of buying foreign currency in terms of domestic currency decreases, causes a decrease in net exports and a decrease in aggregate expenditures.

What It Does

Exchange Rates
Exchange Rates

The exhibit to the right presents a standard Keynesian aggregate expenditures line. Like all aggregate expenditures lines, this one is constructed based on several ceteris paribus aggregate expenditures determinants, such as exchange rates. They key question is: What happens to this aggregate expenditures line if exchange rates change?

Higher Exchange Rate

Suppose, for example, that an organization of central bank representatives from several of the largest nations in the world (call this organization G-8) decide that the currency exchange rate of $2 per pound between U.S. dollars and British pounds is too low. These representatives, through their respective central banks, take the steps necessary to increase the exchange rate up to $2.50 per pound.

This higher exchange rate means that U.S. consumers pay more for any goods purchased from British producers by (that is, imports). A British-made car selling for 10,000 British pounds in Britain costs U.S. consumers $20,000 at the original exchange rate and $25,000 at the new exchange rate. At this higher price, U.S. consumers are bound to buy fewer British-made products, causing imports to decline.

On the other side of the net export equation, British consumers pay less for goods purchased from U.S. producers (that is, exports). An American-made music CD selling for $20 in the United States costs British consumers 10 British pounds at the original exchange rate and 8 British pounds at the new exchange rate. At this lower price, British consumers are bound to buy more American-made products, causing exports to increase.

With imports falling and exports rising, net exports unquestionably increase. And with this increase in net exports goes an increase in aggregate expenditures. To see how an increase in the exchange rates of U.S. dollars for other currencies affects the aggregate expenditures line, click the [Higher Rates] button. The higher exchange rates cause an increase in aggregate expenditures, which is a upward shift of the aggregate expenditures line.

Lower Exchange Rate

Alternatively, suppose that this G-8 organization of central bank representatives decides that the currency exchange rate of $2 per pound between U.S. dollars and British pounds is too high. In these case the representatives work through their respective central banks to decrease the exchange rate down to $1.50 per pound.

This lower exchange rate means that U.S. consumers pay less for any goods purchased from British producers by (that is, imports). A British-made car selling for 10,000 British pounds in Britain cost U.S. consumers $20,000 at the original exchange rate and $15,000 at the new exchange rate. At this lower price, U.S. consumers are bound to buy more British-made products, causing imports to rise.

On the other side of the net export equation, British consumers pay more for goods purchased from U.S. producers (that is, exports). An American-made music CD selling for $20 in the United States cost British consumers 10 British pounds at the original exchange rate and 13.33 British pounds at the new exchange rate. At this higher price, British consumers are bound to buy fewer American-made products, causing exports to decline.

With imports rising and exports falling, net exports now unquestionably decrease. And with this decrease in net exports goes a decrease in aggregate expenditures. To see how a decrease in the exchange rates of U.S. dollars for other currencies affects the aggregate expenditures line, click the [Lower Rates] button. The lower exchange rates cause a decrease in aggregate expenditures, which is a downward shift of the aggregate expenditures line.

What Does It Mean?

Exchange rates are occasionally overlooked as an aggregate expenditures determinant. The primary reason is that net exports are the smallest of the four aggregate expenditure components, which means that relatively big changes in net exports are needed to generate noticeable changes in aggregate expenditures. But, it does happen. And when it happens enough, then the domestic economy can be stimulated to an expansion or thrown into a contraction.

Another possible reason for this lack of notoriety is that the powers-that-be in a country (that is, domestic producers) generally promote the higher exchange rate option to discourage imports and encourage exports. Producers face less competition from foreign products and export more production to other countries. The lower exchange rate option that would trigger the opposite result is seldom promoted. The higher exchange rate is merely a "fact of life," it is how the "world should be." No questions. No debate. But only one side of the possibilities.

<= EXCHANGE RATES, AGGREGATE DEMAND DETERMINANTEXPANSION =>


Recommended Citation:

EXCHANGE RATES, AGGREGATE EXPENDITURES DETERMINANT, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: February 25, 2018].


Check Out These Related Terms...

     | aggregate expenditures determinants | consumer confidence, aggregate expenditures determinant | federal deficit, aggregate expenditures determinant | inflationary expectations, aggregate expenditures determinant | interest rates, aggregate expenditures determinant | physical wealth, aggregate expenditures determinant | financial wealth, aggregate expenditures determinant | change in aggregate expenditures | change in aggregate demand | slope, aggregate expenditures line | intercept, aggregate expenditures line |


Or For A Little Background...

     | aggregate expenditures | aggregate expenditures line | determinants | gross domestic product | consumption expenditures | investment expenditures | government purchases | net exports | Keynesian economics | effective demand | psychological law | exports | imports |


And For Further Study...

     | aggregate market analysis | business cycles | circular flow | monetary economics | aggregate market shocks | Keynesian model | Keynesian equilibrium | injections-leakages model | aggregate demand | aggregate expenditures determinants | fiscal policy | multiplier | net-exports effect |


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