Consider how a currency appreciation might affect national income - Essay Example

Currency Appreciation and National Income Currency appreciation may lead to an increase or a decrease in national income. According to Visser and Visser (2004, p. 58), currency appreciation improves the terms of trade in favour of the nation whose currency is appreciating. What this means is that there is likelihood of imported increasing in volume than the exported goods. This might play out negatively against the nation income considering the fact that GDP = C + I + G + EX – IM Whereby GDP = gross domestic product C = the sum of personal consumption expenditures, I = the private investment expenditures, G = the government consumption expenditures, EX = the expenditures on exports IM = the expenditures on imports To have a clear perspective on this, it should be noted that currency appreciation or depreciation has an effect on key macroeconomic variables which are “economic growth, employment and inflation” (Glanville & Glanville 2011, p. 369). Currency Appreciation and Economic Growth An appreciation of a currency will affect the demand for export goods and supply of import goods.

In both cases, the economy of the nation whose currency is appreciating is on the receiving end (Glanville & Glanville 2011. p. 369). . ore imports without necessarily having to pay more money – the amount of money they used in the past to buy a certain volume of imports will now fetch a bigger volume of the same. Due to human nature, or more precisely according to the basic laws of economics, the local consumers will shift their demand from local goods to imported goods. This will certainly have an adverse effect on the local industries as the demand for their products falls.

Incorporating this effect on the following equation - GDP = C + I + G + EX – IM - means that GDP is lowered (C, I and G are reduced while IM increases). Currency appreciation and exported goods The exports of a nation whose currency is appreciating will become more expensive in foreign markets. Because the currency has appreciated, foreign importers (those buying local good for foreign markets) will have to pay more for the same volume of goods they used to demand before the appreciation of the currency.

In such a situation, the foreign importers will either continue to buy the local goods or will seek alternatives such as getting the goods from different countries where prices are lower or stopping their import business all together. The world is so much connected and the later solution will be more attractive for any forward thinking consumer or organization. This again will see the nation with an appreciating currency lose its export market. Local industries again stand to suffer lower demands of their products.

Substituting this effect in the equation GDP = C + I + G + EX – IM shows that the GDP again suffers because EX reduces. Therefore, in the two situations above, it is very clear that an appreciating currency will prompt the local consumers to shift their demand from local goods to exported goods and foreign