According to the absorption approach,currency devaluation (depreciation) best leads to an improvement in the balance of trade when a country
A) operates at full employment with no excess production capacity
B) operates at unemployment with excess production capacity
C) realizes high rates of inflation
D) realizes high rates of deflation

Question

Quizplus · Accepted Answer

The absorption approach suggests that a currency devaluation (depreciation) will lead to an improvement in the balance of trade if there is excess production capacity in the economy. This is because the devaluation will make exports cheaper and more competitive, leading to an increase in demand for domestic goods and services, which in turn will increase production and employment. If the economy is already operating at full employment, there is no excess production capacity, and any increase in demand for domestic goods and services may lead to inflationary pressures, which could potentially offset the benefits of the devaluation. Therefore, the best choice is B, as devaluation can stimulate production and employment in an economy with excess production capacity.

According to the Absorption Approach,currency Devaluation (Depreciation) Best Leads to an Improvement