What are the Effects of Exchange Control?

Exchange control combined with import licence give rice to monopoly profit to the importer in a country. Suppose in a country following strict exchange control an importer imports commodity X. The situation of demand-supply of X in the country is represented in.

PW is the world price of X. If there is no exchange control OQ will be imported to meet the consumer demand in the country – represented by demand curve DC. This would need OPW EQ amount of foreign exchange.

However, under exchange control releasing limited amount say, OPWST(5 less than the required amount), the importers demand curve will be DM- a rectangular hyperbola curve which is deviated from the consumer demand curve. Obviously, supply is restricted to OT against OQ demand. The domestic price of the imported commodity, thus, rises to PH. The difference between PH and PW is the monopoly rent accruing to the importer.

A steeper demand curve would imply a further monopoly rent profit to the importer.

It follows that exchange control reduces consumer welfare. It also encourages corruption to acquire import licence and foreign currency licence.