The exchange rate and the labor market
Suppose the domestic currency depreciates (E falls). Assume that P and P* remain constant.
a. How does the nominal depreciation affect the relative price of domestic goods (i.e., the real exchange rate)? Given your answer, what effect would a nominal depreciation likely have on (world) demand for domestic goods? on the domestic unemployment rate?
b. Given the foreign price level, P*, what is the price of foreign goods in terms of domestic currency? How does a nominal depreciation affect the price of foreign goods in terms of domestic currency? How does a nominal depreciation affect the domestic consumer price index? (Hint: Remember that domestic consumers buy foreign goods (imports) as well as domestic goods.)
c. If the nominal wage remains constant, how does a nominal depreciation affect the real wage?
d. Comment on the following statement. "A depreciating currency puts domestic labor on sale."