Assume that a country operates at less than full employment and has excess productive capacity.According to the absorption approach, a currency depreciation tends to
A) expand domestic output and improve the balance of trade.
B) expand domestic output and worsen the balance of trade.
C) contract domestic output and improve the balance of trade.
D) contract domestic output and worsen the balance of trade.

Question

Quizplus · Accepted Answer

According to the absorption approach, a currency depreciation expands domestic output by making exports cheaper and imports more expensive, which stimulates demand for domestic products and reduces demand for foreign products. This expansion in output tends to improve the balance of trade because a country is exporting more than it is importing.

Assume That a Country Operates at Less Than Full Employment