Step into my class, Dr Taylor

One of the most basic ideas in economics is called the law of demand. It means that when the cost of something increases relative to its alternatives, people tend to buy less of it. While you can find the rare historical contrary example, the relationship is pretty robust and universal.

However, a few persons insist, for some reason, that the law of demand does not apply to the cost of imports into Jamaica. When the exchange rate rises by more than the rise in the local price level, imports become more expensive relative to domestic goods.

Some feel that this situation is a rare exception to the law of demand - that when imports cost more, people somehow find the extra money to buy them anyway.

Dr Orville Taylor, a sociologist at the University of the West Indies apparently bored with sociology, wrote in last week's Sunday Gleaner that when the US-dollar exchange rate moved from $86 to $89, imports rose from US$1.6b to US$2b. From this observation, Dr Taylor concludes that "trade deficits hardly ever respond to depreciation".

RESPONDING TO DEPRECIATION

Actually, trade deficits respond to depreciation with metronomic regularity all over the world, including in Jamaica. What matters is not the absolute price of something, but the relative price. When currency depreciation exceeds the local inflation rate, the prices of imported goods rise more than local goods, and people on limited budgets are obliged to reduce their consumption of imports.

During the same period that the exchange rate moved from $86 to $89, a modest four per cent rise, prices of local goods rose by even more - 10 per cent. So imports actually became relatively cheaper. As we would expect with a relatively cheaper product, the amount of imports increased. Dr Taylor's data actually corroborate the law of demand.

If you compare the increases in our exchange rate to increases in prices (for the technical, the relevant comparison is actually to the difference in the local and foreign inflation rates), you realise that we have not been really depreciating at all.

KEEPING WITH INFLATION

Twenty-five years ago, when a patty could be had for J$5, the exchange rate was $5.50. Now, when a patty costs $120, the exchange rate is at $100. In other words, if the patty is typical, our currency movements have only just been keeping up with inflation.

If you want to see the positive effect of a real depreciation, the exchange rate has to move by more than the price of the patty.

Jamaica holds a special place in all our hearts. But when it comes to the basic, universal laws of economics, it really isn't that special. When the currency depreciation is more modest than inflation, people respond to the relatively cheaper imports by buying more of them, as evidenced by Dr Taylor's import data. When depreciation is greater, people buy fewer imports. There is just no getting around that.

Dr Damien King is head of Department of Economics, University of the West Indies, Mona. Email feedback to columns@gleanerjm.com and damien.king@uwimona.edu.jm.

Damien King

GUEST COLUMNIST