Exchange Rates and Prices

TL;DR: In this article, the adjustment of relative prices to exchange rate movements is explained in an industrial organization approach, where the extent of absolute and relative price adjustment is shown to depend on market integration, product substitutability, relative number of domestic and foreign firms, and the market structure.

Abstract: The adjustment of relative prices to exchange rate movements is explained in an industrial organization approach. Given labor costs in the respective currencies, exchange rate movements change costs for firms selling in the home market and thus disturb the industry equilibrium. The extent of absolute and relative price adjustment is shown to depend on market integration, product substitutability, the relative number of domestic and foreign firms, and the market structure. The impact of exchange rates on prices is illustrated in a variety of approaches including the Cournot, A. Dixit and J. Stiglitz_(1977), and S. Salop_(1979) models. Some empirical evidence is offered in support of the theory. Copyright 1987 by American Economic Association.