Example of the effect of the exchange rate on imports...

We've said in previous lectures that one correcting impact of the exchange rate is on balance of payments imbalances.  For example, if a country has a huge balance of payments deficit and hence is importing much more than it's exporting, then we'd expect the currency for that economy to depreciate (fall in value, making it more expensive for residents in that economy to get foreign currency).

Here's an example of that happening in the UK: Petrol prices.  Scroll past the fluff and bluster from some MP in the Torygraph, an analyst points out that the pound has weakened against the dollar significantly in the last couple of years (the pound has lost 25% of its value).  This means that as oil is priced in dollars, that even though the current price of oil is $80, we have to spend more pounds to get that barrel of oil compared to when the price was about $140 back in 2008.  Back then we could get $2 for a pound, now it's more like $1.40.  So right now oil's at about £57, but back then it was about £70.  Still quite a few quid difference, but not as dramatic as quoting the price in US dollars.

The point is: The pound has depreciated reflecting weakness in the UK economy, not least the huge balance of payments deficit.  The effect of this depreciation in theory is that imports become more expensive, and our exports become less expensive, and hence we'd expect to see the balance of payment deficit closing.  Here's an example with petrol, of that exchange rate effect.

Will we consume less petrol?  Depends on how elastic our demand is...