Question

Suppose that a Swiss watchmaker imports watch components from Sweden and exports watches to the United States. Also suppose the dollar depreciates, and the Swedish krona appreciates, relative to the Swiss franc. Speculate as to how each would hurt the Swiss watchmaker.

Short answer

The Swiss watchmaker is hurt by increased costs from imported components and higher prices for exports reducing demand.

Step-by-step solution

Understanding Currency Depreciation

The term 'dollar depreciates' means that the value of the US dollar decreases compared to the Swiss franc. This means that each dollar buys fewer Swiss francs than before.

Impact of Dollar Depreciation on Exports

Since the dollar has depreciated, American buyers would need more dollars to purchase the same priced Swiss watches, making Swiss watches effectively more expensive in the US market. This could lead to decreased demand for Swiss watches from the US, harming the Swiss watchmaker's export sales.

Understanding Currency Appreciation

The term 'Swedish krona appreciates' means that the value of the Swedish krona increases relative to the Swiss franc. This means each Swedish krona buys more Swiss francs than before.

Impact of Krona Appreciation on Imports

With the appreciated Swedish krona, the watch components imported from Sweden become more expensive for the Swiss watchmaker. This increases the cost of production for the Swiss watches, squeezing the profit margins of the watchmaker.

Key concepts

Export Costs

When a country's currency depreciates, the costs associated with exporting goods become a critical factor for producers. For a Swiss watchmaker exporting to the United States, a depreciation of the US dollar means that American consumers require more dollars to purchase the same amount of Swiss francs needed for a watch. This effectively raises the price of Swiss watches in the US market, often leading to a reduction in demand.

The increased export costs result in challenges such as:

• Diminished competitiveness of Swiss watches in the US, as consumers may look for cheaper alternatives.
• Potential decrease in sales volume, impacting the revenue generated from U.S. exports.
• Pressure on the watchmaker to either lower prices or find ways to reduce production costs to remain competitive.

Import Costs

The cost of importing goods is significantly affected by currency exchange fluctuations. In the case of the Swiss watchmaker, if the Swedish krona appreciates relative to the Swiss franc, the cost of importing watch components from Sweden rises. This is because the watchmaker will need to spend more Swiss francs to buy the same amount of Swedish krona.

This currency change leads to several consequences:

• Increased cost of raw materials, which directly impacts the cost of production.
• Squeezed profit margins, as higher costs might not be easily passed on to consumers.
• The need for the Swiss watchmaker to explore alternative suppliers or negotiate better terms to mitigate the rising costs.

Currency Appreciation

Currency appreciation, as seen with the Swedish krona in this scenario, affects both import and export markets for businesses. An appreciation means that the currency has increased in value compared to another currency, leading to changes in the buying power.

For businesses like the Swiss watchmaker:

• A stronger krona makes Swedish exports more expensive for buyers using Swiss francs, thus increasing import costs.
• The Swiss franc’s relative decrease in value against the krona reduces the affordability of purchasing Swedish goods.
• Currency appreciation can cause companies to review their sourcing strategies and financial hedging practices to manage currency risks better.