14) Exchange Rates Flashcards
What determines the exchange rate
➡️determined by the influence of demand and supply for that currency
⚫️currencies traded at the FOREX
➡️value of the £ agains other currencies can
➡️go up (appreciate)
➡️go down (depreciate)
➡️depending on how much is being traded on the FOREX market
What does exchange rate mean
The value of one currency expressed in terms of another currency
➡️e.g. £1=$1.50
Who are the £s demanded by
⚫️foreign residents, wishing to
➡️buy UK exports
➡️pay for UK services
➡️invest in the UK
⚫️speculators
➡️expecting a future rise in the Value of the pound
Who are the £s supplied by
⚫️uk resident, wishing to
➡️buy imports
➡️pay for foreign services
➡️invest abroad
⚫️speculators
➡️expecting future fall in the value of the £
➡️or a rise in another currency
What happens if the value of the pound appreciates ➡️price of UK exports (x) ➡️price of imports into the UK (m) ➡️demand for UK exports (x) ➡️demand for imports into the UK (m) ➡️net export (x-m) ➡️AD
➡️price of uk exports ⤴️ ➡️price of imports into the uk⤵️ ➡️demand for uk exports⤵️ ➡️demand for imports into the UK⤴️ ➡️net export ⤵️ ➡️AD⤵️
What happens if the value of the pound depreciates ➡️price of UK exports ➡️price of imports into the UK ➡️demand for UK exports ➡️demand for imports into the UK ➡️net export ➡️AD
➡️price of UK exports ⤵️ ➡️price of imports into the UK⤴️ ➡️demand for UK exports⤴️ ➡️demand for imports into the uk ⤵️ ➡️net exports ⤴️ ➡️AD ⤴️
Evaluate the impact of exchange rate movements on AD
⚫️depends on magnitude of the exchange rate movement
➡️how much the exchange rate appreciates and depreciates
⚫️short run and long run effects
⚫️depends on the PED of exports and imports
Why does any impact on the AD depends on the magnitude of the exchange rate movement
⚫️if the movement is very small
➡️has little effect on AD
Why would the exchange rate movement on AD effect the short run and long run effects
⚫️even if the value of the £ depreciates
➡️uk customers may still buy imported goods in the short run
➡️takes a while for them to adjust to spending patterns
⚫️thus the depreciation of the £
➡️would reduce AD
➡️worsen the trade deficit in the short run
Why does the exchange rate movements on AD depend on the PED of exports and imports
⚫️PED for exports and imports may be inelastic ➡️so appreciation of the £ ➡️which pushes up the price of exports ➡️would increase AD ➡️and reduce trade deficit in short run
What does hot money mean
⚫️used to describe large short term speculative flows of money between countries
➡️speculators move to currency that offers best interest rate
➡️for example
➡️if uk interest rates higher than US interest rates
➡️speculators sell US$ and buy £s
Describe hot money:the effect of an interest rate rise on the exchange rate
➡️uk interest rates increase ➡️uk becomes more attractive place to save ➡️"hot money" flows into the UK ➡️demand for £ increases ➡️value of the £ appreciates ➡️UK exports become more expensive ➡️net exports decreases ➡️ AD decreases
