SFB 303 Discussion Paper No. B - 450
Author: Pope, Robin, and Reinhard Selten
Title: Local Manufacturing Hurt by Depreciations in a Theoretical Model
Reflecting the Australian Experience
Abstract: The model is motivated by data showing that the Australian production
local manufactures is hurt by depreciations and invigorated by
paper briefly presents such evidence and then proceeds to a theoretical
model aims at capturing short-to-medium run exchange rate effects in an
economy with goods and services aggregated into four commodities: Rural
(agricultural, pastoral, forestry, fishing and mining products), imports,
manufactures and services. The latter three are directly consumed. Rural
enter consumption only indirectly after processing by the manufacturing
Exports are exclusively rural goods.
The model has a Keynesian flavour. Production of local manufactures and
is not constrained by the availability of resources and of labour. Variable
unit of output are assumed to be constant. There are also fixed inputs.
inputs are imports in the case of the import sector, rural goods and imports
case of the local manufacturing sector, and labour in the case of the
The prices of imports, local manufactures and services are set by constant
factors on variable costs. This assumption is based on a picture of
competition with constant elasticity of demand at the firm level.
The total production of rural goods is an exogenous parameter. The price of
goods is determined in the export market. It falls with increasing exports.
economy is not assumed to be small in its export market. The domestic
consumption demand schedule is modelled as predetermined in the sense that
the time span under consideration the relationship between quantities
and nominal prices is not affected by the exchange rate. The nominal wage
assumed to be pre-determined in the same sense. No specific functional form
imposed on the consumption demand schedule: the analysis is based on general
assumptions, mainly non-inferiority and gross substitutability.
In view of gross substitutability, there is a competitive relationship
and local manufactures. A depreciation raises the price of imports and
paribus such an increase raises the consumption of manufactures. However the
analysis shows that this enhancing influence of a depreciation on
weaker than other causal channels which work in the opposite direction. An
increase in the price of imports raises variable costs and thereby the price
manufactures. This leads to a decrease in the output of local manufactures.
In the course of the analysis, it is first shown that a uniquely determined
exists for every exchange rate above a lower bound. Then the effects of a
the exchange rate are investigated. In most cases the results are
particular this is true for the output and the price of local manufactures.
conclusions are that a depreciation increases exports and the amount of
provided. In some cases unequivocal results can be obtained only with the
further assumptions. This concerns the domestic price of rural goods, the
trade in domestic prices and import penetration.
Keywords: exchange rate, manufacturing output, imported input costs, exportable
costs, raw materials exports, Australian economy
JEL-Classification-Number: F10, F14, F31, F40
Creation-Date: February 1999
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