Economic Implications of Currency Devaluation

EconomyExternal Sector & TradeStatement-based● MediumStatic

Question

Consider the following statements: The effect of devaluation of a currency is that it necessarily

1.
improves the competitiveness of the domestic exports in the foreign markets
2.
increases the foreign value of domestic currency
3.
improves the trade balance

Options

1 only

Answer

1 and 2

3 only

2 and 3

Explanation

Statement 1 is correct because devaluation makes domestic goods cheaper in foreign currencies, which necessarily improves export competitiveness. Statement 2 is incorrect because devaluation deliberately lowers the foreign value of the domestic currency. Statement 3 is incorrect because a trade balance improvement is not a necessary outcome; it depends on the price elasticity of demand for exports and imports (the Marshall-Lerner condition). > Devaluation guarantees cheaper exports relative to global prices, but a positive trade balance depends on price elasticities. Answer: (a).