In an open economy, devaluation of the domestic currency generally leads to what effect on the general level of domestic prices in the short run?

Introduction / Context:
Devaluation occurs when a country with a fixed or managed exchange rate officially lowers the value of its currency relative to foreign currencies. This has important implications for international trade, balance of payments and the domestic price level. Exam questions often focus on the inflationary impact of devaluation through the import channel. This question asks you to identify the typical effect of devaluation on domestic prices in the short run.

Given Data / Assumptions:

• The domestic currency is devalued relative to foreign currencies.
• The economy imports goods, services and production inputs such as fuel or raw materials.
• We are considering the short run impact on domestic prices.
• Other conditions such as demand and supply are assumed not to offset the main price effect immediately.

Concept / Approach:
When a currency is devalued, more units of domestic currency are required to buy the same amount of foreign currency. This makes imports more expensive in domestic currency terms. As the prices of imported consumer goods rise, and the cost of imported inputs used in production increases, domestic producers often pass on higher costs to consumers. This process contributes to an overall increase in the domestic price level, a form of imported inflation. Therefore, the correct option is the one that states that devaluation leads to an increase in domestic prices through higher import costs.

Step-by-Step Solution:
Step 1: Recognize that devaluation makes foreign currency more expensive relative to domestic currency. Step 2: Understand that imported goods and inputs now cost more in domestic currency. Step 3: Note that firms using imported inputs face higher production costs and often raise their selling prices. Step 4: Observe that consumers pay higher prices for imported consumer goods and for domestic goods that use imported inputs. Step 5: Conclude that domestic prices tend to increase in the short run following devaluation, which matches option A.

Verification / Alternative check:
Think of a country that imports fuel and machinery. After devaluation, the domestic currency cost of fuel rises. Transportation, electricity and many industrial processes become more expensive, and firms pass some of these higher costs onto retail prices. At the same time, imported consumer electronics and other goods also become more costly. The combined effect is a rise in the general price level. Although exports may become more competitive, the immediate effect on prices through the import channel is inflationary, confirming option A as the appropriate choice.

Why Other Options Are Wrong:
Option B is wrong because while prices may fluctuate, the typical and systematic effect of devaluation is an upward pressure on prices, not random movement with no direction. Option C is wrong because devaluation does not make imports cheaper; it makes them more expensive in domestic currency. Option D is wrong because it denies any effect on domestic prices, which contradicts both theory and experience; devaluation affects the cost of imported goods and therefore influences the price level.

Common Pitfalls:
Some learners confuse devaluation with revaluation or appreciation, leading them to think imports become cheaper rather than more expensive. Another pitfall is to focus only on the benefit to exporters and ignore the cost side for importers and consumers. While devaluation can improve export competitiveness, its typical short run effect on domestic prices is inflationary. Keeping both sides in mind helps avoid choosing options that claim falling prices or no impact at all.

Final Answer:
Devaluation of the domestic currency generally leads to an increase in domestic prices due to higher costs of imported goods and inputs in the short run.