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460casestudy#1

460casestudy#1 - Economics 460 Case 1 Protecting your...

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Economics 460 Case 1: Protecting your Hard-Won European Profits Answer sheet 1. How do fluctuations in the exchange rate affect Lenovo profitability? Explain, using part A as your example. (Be sure to define profitability.) As we saw in part A, the Lenovo Corporation has profits of $26.6 million when price is 4000 euros and the exchange rate is 1.40 per euro. It has profits of $15.4 million with the same euro price and an exchange rate of $1 per euro. In general, depreciation of the exchange rate will lead to increased profits while appreciation leads to decreased profits. The reason for this? All production costs are in dollars. A stronger dollar leads to lower per-unit revenue in dollars but the same per-unit cost. We also saw in part A that Lenovo changed its profit-maximizing price once the exchange rate appreciated. Rather than selling at 4000 euros, it chose to sell fewer at 5000 euros. This led to profits of $16 million. Lenovo chose to pass on some of the relatively higher costs (when denominated in euros) in higher euro prices to the purchaser, even though this leads to less quantity demanded.
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