How do exchange rates influence trade between countries?

Exchange rates play a significant role in international trade by influencing the relative price of goods and services between countries. When the exchange rate for a currency changes, it alters the cost of importing and exporting goods. For example, if a country’s currency strengthens relative to another country’s currency, exports from that country become more expensive for foreign buyers, potentially leading to a decrease in export volume. Conversely, imports from the country with the stronger currency become cheaper for domestic consumers, possibly resulting in an increase in imports.

This mechanism directly affects trade balances, as changes in exchange rates create shifts in what consumers and businesses in different countries perceive as affordable. A favorable exchange rate can make a country's exports more competitive internationally, resulting in increased trade volume, while an unfavorable exchange rate can have the opposite effect. Understanding this relationship is crucial for analyzing trade dynamics and the economic implications of currency fluctuations.