ECS3703
Assignment 2
Semester 2 2024
, Question 1: Correcting a Trade Deficit Using Exchange Rates
Explanation:
A trade deficit occurs when a country's imports exceed its exports. For South Africa,
this means that more goods and services are being bought from the rest of the world
than are being sold. To correct a trade deficit, one approach is to influence exchange
rates.
Exchange Rate Mechanism: The exchange rate is the price of one currency in
terms of another. If South Africa has a trade deficit, it may devalue its currency to
make its exports cheaper and imports more expensive.
Devaluation of the Rand:
• Export Stimulation: When the South African Rand depreciates (its value falls
relative to other currencies), South African goods become cheaper for foreign
buyers. This increase in demand for South African goods will boost exports.
• Import Reduction: Conversely, foreign goods become more expensive for
South African consumers when the Rand devalues. This leads to a decrease
in imports as local consumers switch to domestically produced goods.
• Improvement in Trade Balance: The combined effect of increased exports and
reduced imports helps reduce the trade deficit. Over time, this may correct the
deficit as the value of exports begins to exceed the value of imports.
Assignment 2
Semester 2 2024
, Question 1: Correcting a Trade Deficit Using Exchange Rates
Explanation:
A trade deficit occurs when a country's imports exceed its exports. For South Africa,
this means that more goods and services are being bought from the rest of the world
than are being sold. To correct a trade deficit, one approach is to influence exchange
rates.
Exchange Rate Mechanism: The exchange rate is the price of one currency in
terms of another. If South Africa has a trade deficit, it may devalue its currency to
make its exports cheaper and imports more expensive.
Devaluation of the Rand:
• Export Stimulation: When the South African Rand depreciates (its value falls
relative to other currencies), South African goods become cheaper for foreign
buyers. This increase in demand for South African goods will boost exports.
• Import Reduction: Conversely, foreign goods become more expensive for
South African consumers when the Rand devalues. This leads to a decrease
in imports as local consumers switch to domestically produced goods.
• Improvement in Trade Balance: The combined effect of increased exports and
reduced imports helps reduce the trade deficit. Over time, this may correct the
deficit as the value of exports begins to exceed the value of imports.
