A depreciation changes prices across borders, and the whole economy feels it.
A depreciation, step by step
Exports cheaper abroad
A $10 shirt priced at 200 pesos falls to $8 when the peso drops: more sold.
Imports cost more at home
Foreign goods need more pesos, so residents buy fewer.
AD rises
Net exports rise: growth and jobs.
Prices rise
More demand, and imported inputs cost more: inflation.
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An appreciation works the other way. After the 2016 referendum the UK pound fell by about 10%, and inflation rose the next year.
Depreciation
- Growth and jobs: net exports rise.
- Inflation: imports and inputs cost more.
- Current account improves, after a lag.
- Living standards: imported goods cost more.
Appreciation
- Exporters lose sales: growth and jobs may fall.
- Lower inflation: imports are cheaper.
- Current account worsens.
- Living standards: imported goods and travel are cheaper.
The points to remember
- Write it like this: "A depreciation makes exports cheaper and imports more expensive, so (X − M) and AD rise."
- Always name the indicator: inflation, growth, jobs, the current account, living standards.
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The effects on the economy are drawn on an AD/AS diagram, with letters, not numbers. The question below draws a depreciation; an appreciation is the mirror image.
Draw it like this in the exam
- Axes: Price level up the side, Real GDP along the bottom. No numbers and no title.
- Curves labelled at their ends: AD1, AD2 and SRAS.
- A dot where the curves cross, with dashed lines to both axes: PL1, PL2, Y1 and Y2.
- An arrow to show which way the curve shifts.
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Paper 2 asked this in the specimen paper and in November 2025, for 4 marks.
Text D says that the currency has depreciated sharply.
Using an AD/AS diagram, explain the possible effects of the depreciation on inflation.
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How the 4 marks are given
| Marks | What your answer needs |
|---|---|
| 3–4 | A correct diagram and a correct explanation |
| 1–2 | A correct diagram or a correct explanation, not both |
| 3 at most | A diagram with a wrong or missing label |