A 15-minute interactive lesson with Prof. Forest Reinhardt
Exchange Rates' Impact on Business
Thinking about real versus nominal exchange rates can be tricky. Let’s try an example and make sure we can do this.
You work for a company that makes high-grade tires for airplanes, and you import your rubber from a supplier in Thailand. Let’s say that prices in your home country are stable, meaning there’s been no inflation. But, inflation has been 10 percent in Thailand. Meanwhile, the Thai baht has depreciated by five percent against your home currency in nominal terms.
If you guessed that the rubber would be more expensive, you're correct! Prices have gone up by 10 percent, but the change in the nominal exchange rate has only reduced prices by five percent. The net increase in prices for you is five percent. This represents an increase in the real exchange rate.
Now, let's imagine that you're Ellen Guidera and operate a ski resort in Chile. Most of your costs are in pesos in Chile. But most of your guests come from outside the country. If you price in pesos, you can match your revenues to your costs and eliminate currency risk—you only have to worry about filling your resort. Yet, if you do this, your customers take on all of the currency risk. Alternatively, you could price in dollars or some other currency. In that instance, you take on the risk, but your customers have certainty about the price they're paying.
I think it is desirable for business owners to think of the customer first. And the dollar is always more stable than the peso.
I am risk-averse so would not want to take on the risk myself. Additionally, if I price in USD my non-American clients still take on some currency risk.
I'd prefer to match my own revenues to my costs and eliminate the currency risk. It really depends though how much demand I have too. If I'm needing to attract and convert more business then I may opt to price in dollars so customers are more appreciative/attracted to stay.
I chose dollars to alleviate my customers of their risk, as I want them to relax and feel happy as my valued guests. Also, USD is a very stable and reliable currency, so I have no issues with accepting USD, as long as I manage my budget carefully to cover all my pesos costs, which I should be doing regardless.
Because you provide service in Chile, it would be natural for customers, regardless of domestic or international, to pay in local currency.