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Impact of Exchange Rate Changes on Exports and Imports

Here is the assignment - Assistance with one or both parts of the assignment is helpful...

Exercise: Analyze the following and discussion your answers:
(a) Assume the price of a shirt in Florida is USD20 and in Ottawa is CAD25. The exchange rate between USD and CAD is .80. Calculate the effects of an appreciation and a depreciation in the exchange rate on the price of the shirt in US and Canada; and the likely effects on the demand in both countries. Please show all work.
(b) for a company sourcing key inputs in a foreign country, describe the effects of an appreciation and a depreciation in the exchange rate on its input prices and the likely effects on the company's cost of production
Exercise: Using illustrative data show effects of hedged versus non-hedged exchange rate changes on a company's profitability.

Solution Preview

(a) You will have to consider two cases: the shirt is made in the US or the shirt is made in Canada. I will show how to go about the case when the shirt is made in the US. Case for the shirt being made in Canada is similar to this.

If the shirt is made in the US, and sells for USD 20 in Florida, it should sell for (20/0.8) = CAD 25 in Ottawa. That is the price that you have here.
Now suppose the Canadian dollar appreciates against the US dollar, so now you can get more US dollars for each Canadian dollar. Earlier you were getting 0.8 US dollars for each Canadian dollar. Suppose it now becomes 1-for-1. Then you can get 1 US dollar for every Canadian dollar.
Getting back to the shirt, it will still cost USD 20 in Florida, since the shirt is being made there, and exchange rate changes do not influence the domestic price as long as everything is domestic and there are no foreign inputs. But the price in Canada will change. You can now get the shirt for (20/1) = 20 Canadian dollars. Thus you can now get the shirt that you earlier paid CAD 25, for CAD 20. ...

Solution Summary

This solution shows the impact of changes in exchange rates on domestic prices and their impact on GDP.

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