Degree of Monopoly, Pricing and Flexible Exchange Rates

Exchange-rate pass-through is the degree to which a change in the exchange rate is translated into a change in the price of internationally traded goods. The pass-through question took on great importance in the United State in the 1980s with the persistence of its trade deficit in the face of a large depreciation of the dollar. Some delay in adjustment was expected according to the J-curve phenomenon. When the J-curve appeared not to be turning upward, economists began to attribute the intransigence of the US trade deficit in part to the rigidity of prices despite the huge currency shift.1 Explanations of these deviations from the law of one price, however, vary widely. In this chapter we extend some well-known PKE pricing models in an attempt to explain the limited passthrough phenomenon.