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Lesson 26: Balance of Payments & Price Elasticity of Exports

Module 1: Macro Fundamental Analysis

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Video Transcript

in this video we’re going to look at the last tab here of the balance payment spreadsheet and we’re going to be looking at the price elasticity of demand for exports now understanding the price elasticity of demand for exports is important in determining whether total revenue is going to increase as the price of exports increases or decrease potentially as the price of exports increases so in other words are the exports of a given economy sensitive to changes in price or not if we have as an example cars or automobiles here these are considered luxury items and luxury items tend to be price elastic in other words demand for these exports are sensitive to changes in price so with exports which are price elastic or sensitive or luxury items which are sensitive to prices changing this means that when the price of elastic exports increases total revenue tends to drop because as the price increases demand diminishes demand goes down so there is less total revenue in a monetary sense the amount of people demanding the currency decreases so as the price increases for elastic exports the demand for those exports decreases therefore total revenue decreases and demand for the currency of the domestic economy also decreases this would provide a short currency bias on the exporting country of the price elastic exports and conversely this would provide a long bias on the currency of the importer country because now there are less people in that economy converting out of the domestic currency and into the currency of the exporting nation so by definition if there is less demand for the exporter nation’s currency there is also less supply of the importer nation’s currency so less supply creates a long bias on that currency when the price of elastic exports decreases this increases total revenue as the price comes down because that export is sensitive to changes in price demand for that export goes up and this increases overall total revenue as demand for the export goes up this increases the demand for the currency of the exporter nation this creates a long bias on the currency of the export nation and a short bias on the currency of the importer nation why because by definition as demand for the export nation’s currency goes up in line with demand for the export nation’s exports supply of the importer nation’s currency also increases this provides a short bias on the importer nation’s currency if you have price inelastic exports for example oil when the price of the inelastic export increases total revenue increases because unlike with price sensitive exports prices go up but this is really a necessity you know if you are a company and you need to buy oil to run your business you have to continue to buy all you’re not going to buy half the amount just because the price has gone up because you need it so demand doesn’t change very much as the price increases and this is why we see an increase in total revenue this is why we see if the price of oil goes up for example the canadian dollar will go up because oil is a price inelastic export so it increases total revenue and as total revenue increases this means that there is a long bias on the export nation’s currency because as total revenue goes up there are more units of the export nation’s currency which are being demanded and as a result if there is more demand for the export nation’s currency there is going to be an increased supply in the importer nation’s currency causing a short currency bias on the importer nation and with price inelastic exports if the price decreases this also decreases total revenue so we see the oil price come down this has a negative effect on the canadian dollar we see the canadian dollar coming down as well and this is because there is less total revenue and if there is less total revenue there is less demand for the export nation currency and if there is less demand for the exporter nation’s currency there is also going to be less supply of the importer nations currency this creates a long currency bias on the importer nations currency so you can see here on the right hand side this is what it looks like on a graph here we have the blue line representing the luxury products and this line comes down so as price increases the quantity demanded decreases this is what you will see for price elastic exports as price goes up from right to left the quantity demanded comes down with price inelastic exports you can see we have this straight line down the middle and what this represents this black line here is that when you have price inelastic export so exports which are not sensitive to changes in the price as price goes up and down price goes up price goes down the quantity demanded doesn’t change so something to consider if you are looking at the currencies of the importer or exporter nations and you are trying to come to a decision on whether there is a long or short bias on that economy’s currency you want to be taken into account whether its exports are price elastic or price inelastic because that will have an effect on total revenue and therefore in turn it will also have an effect on the demand and supply of the exporter and importer nation or in other words it will determine whether there is a higher rate of conversion into the exporter nation’s currency or a lower rate of conversion into the exporter nation’s currency