Exchange rate fluctuations and foreign sourcing

Document Type

Article

Department or Administrative Unit

Economics

Publication Date

Winter 1994

Abstract

In the literature on international trade theory, currency appreciation (depreciation) detracts from (adds to) the international competitiveness of a country by raising (lowering) the relative prices of its goods (Artus, 1974). What is the process by which currency appreciation leads to higher relative prices for a domestic manufacturer? To what extent do relative product prices increase following currency appreciation?

In addressing these questions, international trade theory has emphasized the case where a firm obtains all of its inputs from domestic sources (domestic sourcing) and those input costs are denominated in terms of the domestic currency. In recent years, however, firms increasingly have obtained inputs from foreign suppliers (foreign sourcing) whose costs are denominated in terms of a foreign currency.

The purpose of this article is to compare the impact of currency appreciation on a firm's costs and prices in two situations: (1) where a firm obtains all of its inputs from domestic suppliers and those input costs are denominated in terms of the domestic currency; (2) where a firm obtains some of its inputs from foreign sources and those input costs are denominated in terms of the foreign currency.

The article concludes that as foreign currency-denominated costs become a larger portion of a company's total costs, an appreciation of the domestic currency leads to a smaller increase in the foreign currency cost of the company's product and a larger decrease in the domestic currency-denominated cost of the firm's output, compared to the cost changes that occur when all input costs are denominated in the domestic currency. This has implications both for the international competitiveness effects of exchange rate changes and for their effects on domestic inflation rates.

Comments

This article was originally published in The International Trade Journal. The full-text article from the publisher can be found here.

Due to copyright restrictions, this article is not available for free download from ScholarWorks @ CWU.

Journal

The International Trade Journal

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