4.3 Exchange Rates

Question 1

Exchange rate definition

Answer 1

The price of a currency expressed in terms of another currency

Question 2

What is a floating exchange rate

Answer 2

A floating exchange rate is determined by the interaction between supply(sellers) and demand(buyers) of the currency

Question 3

What is an appreciation

Answer 3

An increase in the price of a currency in terms of another currency (in a floating exchange rate)

Question 4

Factors affecting floating exchange rates

Answer 4

• interest rates
• inflation rates
• income levels
• price and quality competitiveness
• speculation in currency markets
• foreign investment levels

Question 5

The effect of changes in the exchange rate on consumers

Answer 5

An increase in the exchange rate:
- import prices fall, domestic consumers will be more willing and able to import more goods and services
- increased standard of living, their income can buy more imported goods and services
- a fall in the inflation rate, more imports and less exports leads to downwards pressure on price due to less aggregate demand in the economy, this may benefit consumers as their incomes can effectively buy more goods and services

Question 6

The effect of an increase in the exchange rate producers

Answer 6

An increase in the exchange rate:
- a fall in import prices, firms can import more raw materials and capital, and have decreased average costs
- a fall in the inflation rate, net exports decrease therefore aggregate demand decreases, causing downwards pressure on the price level meaning firms will not have to increase wages or experience menu costs.