The country’s relative productivity is falling. This would cause its currency to:

Question

BlackTom AI · Accepted Answer

A fall in a country’s relative productivity makes its goods and services more costly per unit of output compared with foreign competitors, so its currency will depreciate in the long run.

1) Relevant knowledge and concepts
- Relative productivity: output per unit of input compared to trading partners.
- Unit labor costs and competitiveness: lower productivity raises unit labor costs for a given wage, reducing competitiveness.
- Real exchange rate and PPP/Balassa–Samuelson: higher productivity in tradable sectors tends to appreciate the real exchange rate; conversely, falling productivity leads to real depreciation. In the long run, purchasing-power parity (PPP) and capital market adjustments drive nominal exchange rates toward fundamentals.
- Capital flows and returns: lower productivity reduces expected returns, encouraging capital outflows and putting downward pressure on the currency.

2) Step-by-step reasoning
- Step 1: Relative productivity falls → the country produces fewer tradable goods per worker than abroad.
- Step 2: For given wages, unit labor costs in tradables rise → domestic exported goods become relatively more expensive.
- Step 3: Competitiveness declines → export demand weakens and import demand rises, worsening the trade balance.
- Step 4: Market forces (and PPP in the long run) require a lower real (and eventually nominal) exchange rate to restore competitiveness; additionally, reduced expected returns cause capital outflows, increasing supply of the currency on FX markets.
- Step 5: The combined effect is downward pressure on the currency’s value over time — i.e., depreciation.

3) Intermediate logical steps shown above (no numeric calculation needed).

4) Why the correct answer is correct
Because falling relative productivity raises relative prices and lowers returns, the real exchange rate must adjust downward to reestablish competitiveness; with flexible prices and capital flows in the long run, the nominal exchange rate depreciates accordingly.

5) Why other options are incorrect (brief)
- “Appreciate” or “appreciate in the long run”: inconsistent with reduced competitiveness and capital outflows from lower productivity.
- “Depreciate in the short run”: short-run effects can be ambiguous due to price stickiness or temporary capital inflows, but the canonical long-run outcome is depreciation.

Conclusion: The correct long-run outcome is that the currency will depreciate in the long run, matching the provided answer.

The country’s relative productivity is falling. This would cause its currency to:Single choice

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