13
The absolute price level, P, is a w_ted
av_
of the
.damstlc price indices for importabiesand exportables,wi_h the weights de_
by their _lative shares in cMmes_ic p_uctlon
or consumptlon,A and 1 - _, _spectively. Utillzlng a CobbDouglas function, the domestic price level can be defined as P = _.M l _.X I-_ and its percentagechange as P = X
+ (Z-_)
Since the prices of Importablesand exportablesc_
propor-
tlonatelyWith the exchange rate, so will the _neral price level or P =E. The level of real ex_ture
can be expected to decrease
the price level rises after a devaluation. The price increase lowers the real money supply and the2efore,rmal ex_m_ture.
The_centaS_ charf_e in realexpenditure, Z, due to a chanse in the exchange rate is derived to be: A
-P
z=
-E
i_k) V+ I
I
k) V+ i
where V = PY/M is the income velocity of money. The fall in real expenditurewill bring about a decrease in
a_and for_rtahles andexportables since% = =Z _ and ^ DX =YZ %
B_
Z
....... the
elasticityof demand for Importables,and YZ "
_Dx Z , ........ " --0 x
the expenditureelasticityof demand for exportables_are both asstm_d to be positive. The demand for importablesand exg_rtablesare also functionsof the relative price betweem tl'_,