Changes to the equilibrium exchange rate

Question 1

What happens to the foreign exchange market if there is a rise in imports?

Answer 1

To buy imports UK firms need the £ so demand for £ would rise
Rise in supply creates a surplus of £s which is corrected by the price (exchange rate) depreciating

Question 2

What happens to the foreign exchange market if there is a rise in inward investment?

Answer 2

To do FDI, US firms need the £so demand for the £ would rise.
Rise in demand creates a shortage which is corrected by the price (as exchange rates) appreciating.

Question 3

What happens to the foreign exchange market if there is a rise in interest rates?

Answer 3

Increase in UK interest rates increases the incentive to save rather than consume
Supply of £ of purchase imports reduces
Demand for £ would rise as savers from US have an incentive to put their money into UK banks
Exchange rates appreciates

Question 4

What does the acronym ‘SPICED’ stand for? (can be inverted)

Answer 4

Strong
Pound
Imports
Cheaper
Exports
Dearer

Question 5

What effect will there be on imports and exports if there is a rise in the value of the currency?

Answer 5

Rise in value of currency = Fall in price of imports + Rise in price of exports
expected to lead to rise in demand for imports + fall in demand for exports

Question 6

What does the extent of change in demand depend on?

Answer 6

Elasticity