The Elasticity Approach

Abstract

The adjustment through exchange-rate changes relies upon the effect of the relative price of domestic and foreign goods on the trade flows with the rest of the world. The idea behind the adjustment process under consideration is that a change in the relative price of goods, ceteris paribus, brings about a change in the demands for the various goods by both domestic and foreign consumers, thus inducing changes in the flows of exports and imports which will hopefully adjust a disequilibrium in the payments balance considered.The terms of trade may vary both because of a change in the prices of goods expressed in the respective national currencies, and because the exchange rate changes. The analysis with which we are concerned in this chapter focuses mainly on the changes in the exchange rate.