What role does the exchange rate play in aggregate demand?

The role of the exchange rate in aggregate demand is critical, as it directly influences the competitiveness of a country's goods in the global market. When there are changes in the exchange rate, it affects the price of both exports and imports.

For instance, if a country's currency weakens, its goods become cheaper for foreign buyers, potentially increasing exports. Conversely, imports become more expensive, which can reduce the quantity of imported goods consumed domestically. This dual impact means that fluctuations in the exchange rate can have significant effects on a country's net exports, which is a component of aggregate demand.

Additionally, a stronger currency has the opposite effect, as exports can become relatively more expensive for foreign consumers, potentially leading to a decrease in demand for those exports. Thus, understanding this relationship is essential for analyzing how changes in the exchange rate can lead to shifts in aggregate demand due to their direct impact on the price dynamics of international trade.