How does the exchange rate impact international trade?

The exchange rate plays a crucial role in international trade by determining the value of one currency against another. When countries engage in trade, they must convert one currency into another to facilitate the purchase and sale of goods and services. This conversion is influenced by the exchange rate, which fluctuates based on various economic factors such as inflation, interest rates, and economic stability.

A higher exchange rate means that a country’s currency is stronger compared to another currency, making imported goods cheaper for consumers in that country but making its exports more expensive for foreign buyers. Conversely, a lower exchange rate means that the currency is weaker, which can boost exports by making them cheaper for buyers in other countries, but can increase the cost of imports for domestic consumers. This dichotomy significantly impacts trade balances, consumer choices, and economic relationships between countries.

Other options do not directly relate to the core function of exchange rates within international trade. While interest rates, taxes, and domestic pricing are important economic factors, they do not encapsulate the fundamental role of how exchange rates facilitate and affect international trade dynamics.