4.3 Exchange rates

Question 1

What is meant by exchange rate?

Answer 1

the price of one currency in terms of another currency

Question 2

What determines the UK’s exchange rate against other currencies?

Answer 2

the market forces of demand and supply

Question 3

Where is the exchange rate of a currency set?

Answer 3

At the equilibrium of demand and supply. Where D = S at a price of p

Question 4

What does the equilibrium price show?

Answer 4

shows the external value of a currency, other words, how much of another currency it can buy

Question 5

What is the demand curve for?

Answer 5

the demand for pounds, mostly from overseas economic groups who want pounds to buy British goods, services, and financial assets from the UK

Question 6

What is the supply curve of?

Answer 6

the supply curve is the supply of the pound, mostly from UK economic groups who supply their pounds in exchange for another currency to buy goods, services, and financial assets from other countries

Question 7

What are the 2 possible changes in the exchange rate diagram that can lead to a rise in the exchange rate?

Answer 7

• an increase in demand for the currency (shift to the right)
• a decrease in supply of the currency (shift to the left)

Question 8

What does it mean if the exchange rate rises?

Answer 8

it means the price of a currency increases in terms of another currency. This is also referred to as the currency becoming stronger or as an appreciation of the currency

Question 9

What does a fall in the exchange rate mean?

Answer 9

it means the price of a currency decreases in terms of another currency. This is also referred to as the currency becoming weaker or a depreciation of the currency

Question 10

What are the 2 possible causes of a fall in the exchange rate?

Answer 10

• A decrease in demand for the currency

- An increase in supply of the currency

Question 11

How can the demand for UK exports affect the demand for the pound?

Answer 11

If there is an increase in the demand for UK exports, then demand for the pound will increase since people will be needing more of this currency in order to buy their exports with

Question 12

What are the 4 key reasons why economic groups in the euro zone need pounds?

Answer 12

1: to buy UK exports of goods and services
2: to save in UK bank accounts
3: to speculate on the pound, this is where speculators buy the pound in hopes that it will be worth more money later
4: to invest in the UK, for example, so that overseas producers can set up businesses and trade from the UK as a base

Question 13

What are the 5 reasons why the demand for the pound may increase?

Answer 13

1: UK goods become more desirable, e.g. due to a fall in price if the uk inflation rate falls relative to that in other countries
2: incomes rise in the euro zone, so eurozone consumers have more money to spend on goods, which may include uk exports
3: interest rates in the uk rise relative to other countries’ interest rates, so eurozone savers would want to save more money in the UK to take advantage of the increased rates of interest
4: some eurozone speculators believe the value of the pound will rise in the future, so they think it’s worthwhile to buy pounds now that they can then exchange for more euros in the future
5: the uk may become more attractive for foreign investments, for example due to a reduction in corporation tax or an increase in productivity

Question 14

What happens to the supply of the pound if there is an increase in the demand for imports to the uk, and why?

Answer 14

There will also be an increase in the supply of pounds, this happens because the pounds are sold for euros (or other currencies) that are then used to buy the imports with

Question 15

What are the 4 key reasons as to why British economic groups need euros and will trade pounds for them?

Answer 15

1: to buy imports of goods and services
2: to save in the eurozone bank accounts
3: to speculate on the euro
4: to invest in the eurozone

Question 16

So what are the 5 reasons as to why the supply of the pound may increase?

Answer 16

1: eurozone goods become more desirable
2: incomes rise in the uk, which mean they have more pound sot exchange for euros and can buy more goods which are likely to include imports from the eurozone
3: interest rates from the eurozone rise relative to other countries interest rates, so British savers would want to save more in the eurozone to take advantage of the increased return on their savings
4: the eurozone becomes for attractive for foreign investment, for example due to a reduction in regulations or an increase in productivity

Question 17

How do you calculate a currency conversion of pounds in to euros?

Answer 17

You multiply the amount of pounds by the exchange rate (which is the amount of euros 1 pound would buy) for example £1=€1.20 so £5.70 x €1.20 = €6.84

Question 18

How do you calculate a currency conversion of euros to pounds?

Answer 18

You divide the amount of euros by the exchange rate, for example if £1=€1.20 then €3.45 / €1.20 = £2.88

Question 19

How can the UK’s exchange rate be analysed?

Answer 19

In terms of of other currencies, such as the US dollar or euro

Question 20

What does a change In the exchange rate have impacts on?

Answer 20

On the prices of exports and imports

Question 21

What are the 6 possible effects if the exchange rate falls?

Answer 21

1-an increase in the total demand: this is likely because demand for exports will increase, but decrease for imports due to the relatively more competitive domestic prices
2-an increase in domestic output (GDP) and economic growth: this is likely because output will increase in order to meet the increased demand for domestic goods
3-a decrease in unemployment: this might happen because more workers are needed to make the extra output
4-a current account surplus: this might happen if export revenue is higher than import spending
5-a rise in inflation: this might happen due to the increase in total demand and the upwards pressure on prices
6- a decrease in total supply: this may happen if the country imports s lot of it’s raw materials and capital goods, so as the price of these increase it becomes more costly for producers

Question 22

What are the 5 effects of changes in the exchange rate on consumers (say there was a rise)

Answer 22

1-import prices fall: domestic consumers may be more willing and able to buy imported goods
2-an improved standard of living: domestic consumers may enjoy a better standard of living as their income can buy more goods
3-increased tourism overseas: more domestic consumers may go on holiday as their Currency will buy more of the foreign currency
4-a fall in interest rates: the Bank of England may lower interest rates in order to enable British producers to borrow more money at lower costs so that they can invest in production and become more internationally competitive. The knock-on effect is that consumers will too benefit since now the lower prices of mortgages and credit cards means they will have more money left to use, so they can consume more
5-a fall in the inflation rate: this would be due to total demand for domestic goods falling. If imports grow and exports fall, there is likely to be a downwards pressure on the price level of domestic goods. This may benefit consumers since now their incomes will buy more goods.

Question 23

What are the 5 effects of changes in the exchange rate on producers? (Say there was a rise)

Answer 23

1-a fall in import prices: this would be a benefit for producers who import raw materials, components, or capital goods, as now their average costs will be lower and there is a chance of increased profits
2-a rise in export prices: usually this would expect to result in a fall in demand for goods from British producers. However, if overseas consumers have an inelastic price elasticity of demand for these British goods, then the increase in price won’t affect the quantity demanded from them by much
3-increased tourisms overseas: producers involved in the provision of holidays overseas, for example travel agents and air-lines, should benefit greatly from the increased demand from British consumers. However producers involved in providing holiday and leisure services in the uk may suffer due to less demand from both British and overseas consumers
4-a fall in interest rates: the Bank of England may lower interest rates in order to allow producers to borrow more money at a lower cost, so that they can invest in production and become more internationally competitive. This in turn should reduce average costs for producers and help increase market share globally
5-a fall in the inflation rate: due to total demand falling, if exports rise and imports fall there is likely to be a downwards pressure on the price level. This may benefit producers as there is less need for wage rises, it should lower menu costs and eventually British producer should become more internationally competitive again