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© 2014 Pearson Canada Inc.#
What are the factors that affect exchange rates in the long-run?
Answer:
a. Relative price levels: According to PPP when domestic price level rises relative to foreign, the
domestic currency will depreciate.
b. Trade barriers: when we impose trade barriers to imports then domestic currency will
appreciate.
c. Preferences for domestic versus foreign goods: when foreigners develop an appetite for
Canadian goods, then the Canadian dollar will appreciate.
d. Productivity: In the long-run as a country becomes more productive relative to other countries,
its currency appreciates.
Diff: 3 Type: SA Page Ref: 475 - 476
Skill: Recall
Objective List: 19.2 Identify the factors that lead to changes in the exchange rate in the long run
Explain how trade barriers affect the exchange rates in the long-run
Answer: Increasing trade barriers cause a country's currency to appreciate in the long run. For
example, suppose that Canada increases its tariff or puts a lower quota on Japanese cars. These
increases in trade barriers increase the demand for Canadian cars, and the dollar tends to
appreciate because Canadian cars will still sell well even with a higher value of the dollar.
Diff: 3 Type: SA Page Ref: 475
Skill: Recall
Objective List: 19.2 Identify the factors that lead to changes in the exchange rate in the long run
Explain how productivity affects exchange rates in the long-run
Answer: When productivity in a country rises, it tends to rise in domestic sectors that produce
traded goods rather than nontraded goods. Higher productivity is therefore associated with a
decline in the price of domestically produced traded goods relative to foreign-traded goods. As a
result, the demand for domestic goods rises, and the domestic currency tends to appreciate.
Diff: 3 Type: SA Page Ref: 476
Skill: Recall
Objective List: 19.2 Identify the factors that lead to changes in the exchange rate in the long run