Suppose that the average price of goods imported from Great Britain increased. Is it likely that the value of the Australian dollar would appreciate or depreciate versus the British pound, ceteris...

Suppose that the average price of goods imported from Great Britain increased. Is it likely that the value of the Australian dollar would appreciate or depreciate versus the British pound, ceteris paribus? Is it likely that the average price in British pounds of goods exported from Australia to Great Britain would rise or fall?

Expert Answers
pohnpei397 eNotes educator| Certified Educator

If the average price of goods imported from Great Britain rises, and if all other things truly are equal, then the value of the Australian dollar will depreciate relative to the pound and the price in pounds of Australian exports to Britain will fall.

Exchange rates are typically determined by supply and demand.  In the scenario you lay out here, the demand for pounds will rise as will the supply of Australian dollars.  Both of these changes will cause the value of the Australian dollar to depreciate.  If the price of British imports rises, Australian importers will need to buy more pounds to pay for those goods.  They will pay for those pounds in dollars.  When they do this, the demand for pounds rises (they need more of them) and the supply of dollars also rises (more are being put out on the foreign exchange market to buy pounds).  We know that when demand rises, the price also rises.  Therefore, the price of pounds will rise.  We also know that as supply rises, prices fall.  Therefore, the price of dollars will fall.  As the price of pounds rises and the price of dollars falls, the dollar will depreciate and the price in pounds of Australian exports will fall.