FIGURE 3 EXCHANGE RATES AND AGGREGATE DEMAND AND SUPPLY
Assume that the economy initially begins in equilibrium at point e, with full employment output Qf and the price level at Pe. Assume that the dollar depreciates. This will increase exports, shifting aggregate demand from AD0 to AD1 and raising prices to P1 and output to Q1 in the short run. In the long run, short-run aggregate supply will shift from SRAS0 to SRAS1, as workers readjust their wage demands in the long run, thus moving the economy to point b. As the economy adjusts to a higher price level, the benefits from currency depreciation are greatly reduced.