Example: Transparency

key terms

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currency

depreciation

exchange rate

monetary union

international trade

Greater price transparency leads to greater competition and lower prices

With a common currency it is easier to compare prices of goods from one country to another.

Let’s say you are interested in buying a pair of pants. Before the monetary union, you would look and see that pants cost either 100 mark in Germany or 8000 pesetas in Spain.  You could go and look at exchange rate to convert the prices into a common currency to see which is more expensive. Right before the formation of the union, the exchange rate between the mark and the peseta was 100 mark = 8507 pesetas. So with 100 mark you could buy a pair of pants in Germany, but had you exchanged your 100 mark for pesetas you could have bought the pants and had 507 pesetas remaining. The pants are more expensive in Germany. Exchange rates often fluctuate, and can even change hour to hour. Even though the price of the pants could stay the same in each country, the pants could be more expensive in Germany one day and Spain the other. For example, if the exchange rate depreciation to 100 mark = 7500 pesetas, the pants are now cheaper in Germany (note they still cost 100 mark in Germany and 8000 pesetas in Spain).  Thus it is hard to determine who really has the better priced pants.

Now assume you have a common currency and pants are 100 € in Germany and 98 € in Spain. Now you know who has the lower prices on pants.  Smart and well informed shoppers will start buying more and more Spanish pants and less and less German pants as trade increases. Because the consumer knows more about prices across countries, the pants market becomes more competitive. The German pants maker will either go out of business or find a better way to make pants. Competition can make the German pants maker more efficient, even to the point where it can sell pants cheaper than its Spanish counterpart. In the end pants are now cheaper for all consumers. 

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