The Effects of Real Exchange Rate Changes on the Brazilian Shoe Manufacturer
In order to preserve its dollar profit margin (but not its inflation-adjusted real margin), the firm will have to raise its price to $14. (Why?1) But if it does that, it will be placed at a competitive disadvantage. By contrast, scenario 2 shows that if the real devalues by 50%, to $0.01, the real exchange rate will remain constant at $0.02 ($.01 × 2/1), the Brazilian firm’s competitive situation will be unchanged, and its profit margin will stay at $6. Its inflation-adjusted real profit margin also remains the same. Note that with 100% inflation, today’s R300 profit margin must rise to R600 by year’s end (which it does) to stay constant in inflation-adjusted real terms.