Suppose that, in the context of the price-specie-flow mechanism, Switzerland currently exports 5,000 units of goods to Spain, with each export unit having a price of 100 Swiss francs. Hence, Switzerland’s total value of exports to Spain is 500,000 Swiss francs. At the same time, Switzerland imports 410,000 francs’ worth of goods from Spain, and thus has a trade surplus with Spain of 90,000 Swiss francs (= 500,000 francs – 410,000 francs). Because of this trade surplus, suppose that all prices in Switzerland now rise uniformly by 10 percent, and assume that this rise in price of Swiss goods causes its imports from Spain to rise from their initial level of 410,000 francs to a level of 440,000 francs. (For purposes of simplicity, assume that the price level in Spain does not change.)
Suppose now that the elasticity of demand of Spanish consumers for Swiss exports is (ignoring the negative sign) equal to 2.0. With the 10 percent rise in the price level in Switzerland, the Swiss export price for each unit of its exports thus rises to 110 francs. With this information, calculate the resulting change in quantity and the new total value of Swiss exports. Has the price rise in Switzerland been sufficient to eliminate its trade surplus with Spain? Why or why not? Alternatively, suppose that the elasticity of demand of Spanish consumers for Swiss exports (again ignoring the negative sign) is equal to 0.2. With the 10 percent rise in Swiss export prices, what happens to Switzerland’s trade surplus with Spain in this case?