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Exchange Rates and Perfect Competition

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  • Thorsten Hens
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    Abstract

    We consider two types of firms both operating in two countries. The demand side of the markets of the two countries are separated and each type of firm produces its good in one of these countries. We study the effect of an exchange rate change on the competitive equilibrium prices in each country. When producing for the foreign market causes the same costs as producing for the home market then the `Law of one Price' holds and an exchange rate change is completely offset by price changes. Furthermore when cost functions are additively separable between producing for the home and producing for the foreign market then prices move in the `right' direction in response to an exchange rate change. However, with general cost structures, even in this simple competitive model, any direction of price changes can result from an exchange rate change.

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    File URL: http://www.wiwi.uni-bonn.de/bgsepapers/bonsfa/bonsfa466.ps
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    Bibliographic Info

    Paper provided by University of Bonn, Germany in its series Discussion Paper Serie A with number 466.

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    Date of creation: Dec 1994
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    Handle: RePEc:bon:bonsfa:466

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    Postal: Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany
    Fax: +49 228 73 6884
    Web page: http://www.bgse.uni-bonn.de

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    1. Hens, Thorsten & Jager, Eckart & Kirman, Alan & Phlips, Louis, 1999. "Exchange rates and oligopoly," European Economic Review, Elsevier, vol. 43(3), pages 621-648, March.
    2. Feinberg, Robert M, 1991. "The Choice of Exchange-Rate Index and Domestic Price Passthrough," Journal of Industrial Economics, Wiley Blackwell, vol. 39(4), pages 409-20, June.
    3. Feinberg, Robert M, 1986. "The Interaction of Foreign Exchange and Market Power Effects on German Domestic Prices," Journal of Industrial Economics, Wiley Blackwell, vol. 35(1), pages 61-70, September.
    4. Paul Krugman, 1986. "Pricing to Market when the Exchange Rate Changes," NBER Working Papers 1926, National Bureau of Economic Research, Inc.
    5. Alan Kirman & Louis Phlips, 1996. "Exchange-rate pass-through and market structure," Journal of Economics, Springer, vol. 64(2), pages 129-154, June.
    6. Froot, Kenneth A & Klemperer, Paul D, 1989. "Exchange Rate Pass-Through When Market Share Matters," American Economic Review, American Economic Association, vol. 79(4), pages 637-54, September.
    7. Dunn, Robert M, Jr, 1970. "Flexible Exchange Rates and Oligopoly Pricing: A Study of Canadian Markets," Journal of Political Economy, University of Chicago Press, vol. 78(1), pages 140-51, Jan.-Feb..
    8. Sven W. Arndt & J. David Richardson, 1988. "Real-Financial Linkages Among Open Economies," NBER Working Papers 2230, National Bureau of Economic Research, Inc.
    9. Rudiger Dornbusch, 1987. "Exchange Rates and Prices," NBER Working Papers 1769, National Bureau of Economic Research, Inc.
    10. Feinberg, Robert M, 1989. "The Effects of Foreign Exchange Movements on U.S. Domestic Prices," The Review of Economics and Statistics, MIT Press, vol. 71(3), pages 505-11, August.
    11. Marston, Richard C., 1990. "Pricing to market in Japanese manufacturing," Journal of International Economics, Elsevier, vol. 29(3-4), pages 217-236, November.
    12. Sibert, Anne, 1992. "Exchange Rates, Market Structure, Prices and Imports," The Economic Record, The Economic Society of Australia, vol. 68(202), pages 233-39, September.
    13. Fisher, Eric, 1989. "Exchange rate pass-through and the relative concentration of German and Japanese manufacturing industries," Economics Letters, Elsevier, vol. 31(1), pages 81-85.
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