You own a small business, Batterido, in a country called Prica. You import the raw materials that you use to make your products in Prica, then sell your products in the domestic market. In other words, you import the inputs and your firm’s outputs are sold only in Prica. Prica’s currency is called liret (abbreviated as PLT). Since early summer, PLT has been losing value against the other major currencies such as US Dollar (USD), Euro, Japanese Yen, British Pound, and Chinese Renminbi. Below is how PLT’s value has changed compared to the USD in the past few months: July 2020: 1 USD = 4 PLT September 2020: 1 USD = 6 PLT As 1 USD equaled 7 PLTs in October, Prica’s Central Bank (equivalent of the Federal Reserve in the United States) decided to increase the interest rates in order to prevent PLT depreciating further against the USD and other major currencies. Prica’s Central Bank was successful: as soon as the interest rates were raised, PLT stabilized and stopped losing value. a. Explain the relationship between the interest rates and PLT’s value. Why does an interest rate increase in Prica prevent PLT from losing value? b. How does the interest rate increase and the subsequent stabilization of PLT’s value impact Batterido, your business? Is the new high interest environment in Prica a positive development for your business, or a negative one? Why?
You own a small business, Batterido, in a country called Prica. You import the raw materials that you use to make your products in Prica, then sell your products in the domestic market. In other words, you import the inputs and your firm’s outputs are sold only in Prica. Prica’s currency is called liret (abbreviated as PLT). Since early summer, PLT has been losing value against the other major currencies such as US Dollar (USD), Euro, Japanese Yen, British Pound, and Chinese Renminbi. Below is how PLT’s value has changed compared to the USD in the past few months:
July 2020: 1 USD = 4 PLT
September 2020: 1 USD = 6 PLT
As 1 USD equaled 7 PLTs in October, Prica’s Central Bank (equivalent of the Federal Reserve in the United States) decided to increase the interest rates in order to prevent PLT
a. Explain the relationship between the interest rates and PLT’s value. Why does an interest rate increase in Prica prevent PLT from losing value?
b. How does the interest rate increase and the subsequent stabilization of PLT’s value impact Batterido, your business? Is the new high interest environment in Prica a positive development for
your business, or a negative one? Why?
Explain in detail.
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