Intermediate macro on the effect of inflation on exports and imports Term Paper

Intermediate macro on the effect of inflation on exports and imports - Term Paper Example Inflation makes reserves to be misallocated. The paper explores how influence impacts on trade among nations, especially its effect on exports and imports. Effect of inflation on exports and imports Introduction Inflation refers to the decrease in the value of money as the prices of goods and services gradually increase overtime. Moderate forms of inflation are conceived normal in the majority of economies and desirable in any economy since this is indicative to producers that there is an increasing demand and so stimulates enhanced production, and ultimately economic growth (Evans, 2004). Nevertheless, high inflation, is worrying since the prices of goods and services rise faster that the surge in wages, thus eroding real incomes. Inflation renders exports to fall, as it costs other countries more to purchase similar amount the same goods. This relationship can be outlined mathematically by the equation NI= C+ I+ G- NX whereby NI represents national income (or price level that equat es to inflation), C represents consumption (consumer spending) I represent investment; G represents government spending while NX represents net exports. Inflation influences the current account deficit since then demand for exports plunges as prices rise, and imports become more competitive if imports prices reduce comparatively lower to domestic competitors (Ulke & Ergun, 2011). If the country is exporting and the local currency becomes strong, then the country’s products become more expensive for its buyers. If a country is relying heavily on imports and the local currency becomes weak, then the products that are imported becomes expensive (Evans, 2004). As such, inflation increases will lead to deterioration of balance of payments since domestic inflation stimulates import spending provided that imports emerge comparatively cheaper, and diminish export sales, as exports emerge more expensive abroad (Levi, 2009). The association between inflation and exchange rate appears a s a double-edged sword whereby the rising inflation tends to render a currency to depreciate (owing to the reduced demand for the country’s demand). Mostly, depreciation aids exporters since prices paid by the overseas buyers decrease (Ulke & Ergun, 2011). Nevertheless, depreciation signifies that prices of imports increase, which is inflationary. The net impact of the devaluation in inflation hinges on the comparative price elasticity of imports and exports. Effects of Inflation on Imports and Exports Exchange rates bear a significant effect on a country’s economy. If the exchange rate drops, this alters the comparative prices of imports and exports. Exports are likely to become comparatively cheap in other currencies while imports become expensive. For instance, when the U.S. purchases imports, the imports are incorporated into the retail price index. In the event that the price of import rises, this could be inflationary, especially in cases where a country’s imports feature a lot of raw materials and semi-finished products (Levi, 2009). A gradual rise in prices will impact on a country’s trading performance mainly on the ration between imports and exports. The performance of a country’