Thu. Jun 20th, 2019

Rupee is plummeting!


By Rashid Ullah Khan 

Everyone is concerned about the macroeconomic conditions of Pakistan. But have you ever wondered how exactly do the decisions individuals take influence the macroeconomic variables and how do the macroeconomic variables influence our decisions?

Theory:

Law of demand: Holding everything else constant an increase in the price of a good lowers its quantity demanded.

Planet Pakfor:

  • Planet Pakfor has two countries: Pakistan and Foreign.
  • The currency of Pakistan is Rupees (RS) and the currency of FOREIGN is dollars($).
  • Pakistan produces fruits and vegetables
  • Foreign produces beef and mutton.
  • There are no trade restrictions I.e Pakistan can easily sell its products in Foreign, and vice versa.

How much of a good produced in Pakistan will the Foreigners demand?  The demand for a good with a certain price is determined by the tastes of the people, for example, If the people of Pakistan suddenly go vegetarians, then they will not demand any of the goods produced in Foreign.

Determination of Exchange rate:

Foreigners purchase Pakistani goods by paying in Pakistani Rupees, and Pakistanis can buy foreign goods by paying in dollars. Thus, it suggests that Pakistanis will need a stock of Dollars to buy foreign products (beef and meat). On the other hand, the higher the demand for Pakistani goods the higher will be the value of Rupee in terms of the Dollar. Which suggests that the value of a currency is determined by the demand for it in the foreign market.

On planet Pakfor Pakistanis are producing fruits and vegetables, thus when foreigners buy fruits or vegetables they demand the Pakistani Rupee. What will happen if all of Pakistanis go vegetarians? Will there be any demand for any foreign products? No, because Pakistanis will no more consume any of the goods produced in Foreign. If the Pakistanis suddenly go vegetarian, the Dollar value will plummet.

What happens when a currency appreciates or depreciates?

Suppose that Pakistani Rupee and Foreign Dollar are valued equally on the Planet Pakfor. The depreciation of the Pakistani Rupee in terms of Foreign Dollar will make Pakistani goods cheaper in the Foreign market, and the revaluation of Pakistani Rupee will make the Pakistani goods more expensive in the foreign market. Similarly, the depreciation of Pakistani Rupee makes Foreign goods more expensive in Pakistan, and the revaluation of the Rupee makes foreign goods cheaper in Pakistan.

The exchange rates table shows relative prices of the currencies on the planet Pakfor before and after the devaluation.

Exchange rates table:

Country Currency Price (Before) Price (After)
Pakistan Rupee (RS) 1 RS=1 $ 1 RS = 2 $
Foreign Dollars ($) 1 $=1 RS 1 $ = 0.5 RS

The following table shows the prices of goods in terms of dollars and Rupees before and after the devaluation of the currency.

Goods prices table:

Country Before (price of meat) After (price of meat) Before (price of fruits) After (price of fruits)
Pakistan 1 Rs 0.5 Rs. 2 Rs 2 Rs
Foreign 1 $ 1 $ 2 $ 4 Rs.

It could be seen that the decline in the value of Dollar in terms of Pakistani Rupee have made the goods produced in foreign (meat) cheaper for Pakistani consumers. Whereas, Pakistani goods have now become more expensive in Foreign. Meat consumption will increase in Pakistan on Planet Pakfor, if everything else remains the same, because of the decline in the price. 

Summary:

Devaluation of the currency of a country makes its exports cheaper and the revaluation of the currency of a country makes its exports more expensive. Similarly, with the decline in the value of the currency of a  country its imports become more expensive, and with the increase in the value of the currency, its imports become cheaper.

The contributor is a BS Economics student at IBA Karachi.

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