Author(s)
Susan Athey and Maya Cohen Meidan
Source
Working Paper No. 3355, 2010
Summary
This paper examines how exchange rates affect consumer demand in markets where advertising is important.
Policy Relevance
Advertising mitigates the effect of currency exchange rate movements on domestic and foreign demand for goods.
Main Points
- It is well understood that when one country’s currency depreciates—becomes cheaper, in terms of other currencies—that country’s goods often become cheaper in other countries, leading to increased consumption of those goods abroad.
- In observed cases, prices of goods change slowly relative to currency price movements. This is called “incomplete pass through.”
- For example, if a dollar were worth 2 euros today, and in a year worth only 1 euro, the price of US goods in Europe might drop by only 10% (instead of 50%) because of incomplete pass through.
- This paper points out that advertising may be a cause of incomplete pass through.
- Sometimes the price of a country’s goods is determined separately in each foreign country, as is the case for region-coded DVDs or textbooks. In this case, if one country’s currency depreciates, advertising abroad will become more expensive. The country’s firms may cut back on foreign advertising, and cause some drop in foreign demand.
- If the price of a country’s goods is set in a single world market, like airfare, depreciation will cause domestic price increases rather than foreign price decreases. However, domestic advertising will become cheaper, offsetting the effect of the local price increase on domestic consumption and reducing pass through.
- Data from Microsoft’s search advertising platform suggest that advertisers do respond to exchange rate fluctuations, and that these fluctuations affect the volume of international transactions through the platform.