Economics Theme 2.4.4 Flashcards
What are exchange rates
Exchange rates are the cost of one currency in terms of another currenc
how are exchange rates determined
Exchange rates are determined by supply and demand
what happens if the demand for a currency goes up
As demand for one currency goes up its price (exchange rate) will go up, just like a good or service
if supply goes up what happens goes up what happens to the currency
If supply goes up price (exchange rate) will go down
if someone changes a currency
If you are visiting France you will supply £ and demand Euro
what happens to trade if the pound is strong
Strong
Pound
Imports
Cheaper
Exports
Dearer
what happens to trade if the pound is weak
Weak
Pound
Imports
Dearer
Exports
Cheaper
what is the effect of demand of the pound going up
As demand for £s rises the exchange rate rises
e.g. £1 = $1.45 increases to £1 = $1.55
The pound has become stronger
what effects the demand for the pound
Factors influencing demand:
Demand for UK products
Interest rates attracting or pushing away foreign investment
Rate of Foreign Direct Investment (FDI)
what is transactional demand
Demand for the currency derives from people wishing to buy goods and services from that country
For example, this may come about as companies produce products that are in high demand on the world stage e.g. petrol
What is speculative demand
Higher interest rates attract speculators to UK banks in order to achieve a higher return
Foreign currency dealers will speculate whether a currency will appreciate or depreciate in the future
As the supply of the pound increases what is the effect
As supply £s rises the exchange rate falls
e.g. £1 = $1.45 falls to £1 = $1.35
The pound has become weaker
what factors influence supply
factors influencing supply:
Demand for imported products
Interest rates attracting or pushing away foreign investment
A fall in UK interest rates
what does increase in supply do
Increases in supply of a currency will cause it to depreciate.
A depreciation in the exchange rate will make exports cheaper so, over time, there should be an increase in exports.
WPIDEC = Weak pound, imports dearer, exports cheaper.
what does depilacion do to trade
in the short run an exchange rate depreciation will make imports more expensive
what is the effect of inelastic imports
if the import is price inelastic e.g. petrol then total spending on the import will increase
why is the total spending on imports negative
This can cause serious problems for an economy and actually worsen the current account
In particular, there will be inflationary pressure in the economy due to the rise in prices
It is very difficult for a government to control this as it causes cost push inflation
why is it long run it is easier in to substitute domestic products for imported ones
As consumers, firms and government become more aware of the increased prices of imports they will try to change their spending habits
For example, around the globe we are seeing a movement of people away from the use of petrol for cars to alternative forms of transport such as electric cars or cycling
what is Aggregate demand
the total demand for goods and services within a particular market.
What is The effect of exchange aggregate demand
Encourages imports and discourages exports leading to a fall in AD, affecting firms as a whole in the UK
What is the impact of exchange rate on employment
Reduced output leading to lower employment as firms lay off workers
What is the impact of exchange rates on inflation
Cheaper imports and falling AD leading to lower inflation, reducing costs for firms
What is the impact of exchange rates on current accounts
Fall in exports and rise in imports leading to a worsening of the balance of payments
where will global investors invest the most
Global investors who have significant sums of money to deposit in banks will seek to place it in the country where they get the best return i.e. where the interest rate is highest
What will investors do if uk raises its interest rates
If the UK raises interest rates, then investors will move their money to the UK in order to get the best return
This means they will have to sell their dollars, and buy pounds to deposit in the UK
This increased demand for UK pounds increases the exchange rate
This then feeds through to exports, making them relatively less price competitive, and making imports more attractive
his will have the effect of making it harder for UK firms to export their goods and services
At the same time, firms that import goods and services will find that their costs have reduced, making them more competitive
What is the effective exchange rate
The effective exchange rate is a measure of the value of currency e.g. the Pound against a basket of other currencies e.g. the Dollar, the Euro, the Yen
