ChainWhat it assumes · how to break it
Start
The pound depreciates, making UK goods and UK holidays cheaper for foreign buyers.
1
As a result, UK exports become cheaper in foreign currency and imports become dearer in pounds.
SPICED · price competitiveness
SPICED · price competitiveness
Assumes: UK firms pass the exchange rate change into foreign prices.
But: Exporters may keep their foreign prices unchanged and take the gain as higher sterling profit margins, so export prices abroad do not fall.
2
Therefore, foreign buyers switch towards UK goods and services, and UK buyers switch from imports to domestic substitutes.
expenditure switching · PED
expenditure switching · PED
Assumes: Demand for UK exports and imports is price elastic.
But: Many UK exports, such as financial services and pharmaceuticals, compete on quality and reputation, so demand for them is price inelastic.
3
This means net exports rise, so aggregate demand increases.
AD = C + I + G + (X − M) · net exports
AD = C + I + G + (X − M) · net exports
Assumes: The Marshall–Lerner condition holds, so the value of net exports rises.
But: In the short run volumes respond slowly while each import costs more in pounds, so net exports can fall at first (the J-curve).
4
Consequently, export industries such as manufacturing and tourism, and firms competing with imports, sell more output, so their demand for labour rises.
derived demand
derived demand
Best link to attack
Assumes: Firms meet extra demand by hiring more workers.
Assumes: Firms meet extra demand by hiring more workers.
But: Firms may first use spare capacity and overtime, and they will not take on permanent staff if they expect the pound to recover.
5
Therefore, unemployment falls, especially demand-deficient unemployment in regions with many exporting firms.
cyclical (demand-deficient) unemployment
cyclical (demand-deficient) unemployment
Assumes: The unemployed have the skills and live in the places where the new jobs are.
But: Occupational and geographical immobility mean vacancies in, say, advanced manufacturing may not be filled by unemployed workers from other sectors.
End
Employment rises and unemployment falls, mainly in export and import-competing industries.
Evaluation chain
- E1However, the rise in employment depends on firms meeting extra export demand by hiring rather than by using workers they already have.
- E2If firms have spare capacity or expect the pound to bounce back,
- E3then they raise output through overtime and existing staff, or take the depreciation as higher profit margins without expanding.
- E4So employment rises by less than the rise in exports suggests, and only if the lower pound is expected to last will firms create many permanent jobs.
Another way to attack it: Firms that rely on imported inputs, such as retailers and food processors, face higher costs and may cut jobs, so some of the gain in exporting sectors is offset elsewhere.
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Questions this answers
- Explain how a depreciation of the pound could affect employment in UK manufacturing.
- Assess the impact of a fall in the exchange rate on unemployment in the UK.
- Discuss the likely effects of a weaker currency on different UK industries.
Diagram
AD/AS: AD shifts right and real GDP rises; or a labour market diagram where the demand for labour in an export industry shifts right.
Reverse and related
Appreciation → exports fall → derived demand for labour falls in export industries → unemployment rises.