Exchange Rate Changes and the Choice of Technique

Abstract

Shortly after the appearance of his ‘absorption’ approach to the effects of devaluation, S. S. Alexander [1] was criticised by Fritz Machlup [3] for conducting his argument in terms of the overall price level rather than in terms of relative prices and, therefore, failing to take account of resource allocation effects resulting from relative price changes. In this essay we consider a dynamic absorption model (dynamic in the sense of steady growth) which is of a rather more disaggregated variety than usual. Since it is set in a Sraffa-Leontief framework relative prices are of central importance, but not merely because of straightforward consumer substitution effects. Because of production interrelationships, relative prices exercise an influence on the choice of technique appropriate to any exchange rate. This, in turn, may lead to modifications of the traditional absorption conclusions.

This essay is a substantially revised version of an article of the same title which appeared in Economic Record, 1977. I am grateful to Ian Steedman for drawing my attention to an important contradiction in the original paper and for suggesting many other improvements. I should also like to thank J. S. Metcalfe and two referees of the Economic Record for their helpful comments.