Exchange Rates

What is an Exchange Rate?

It’s the value of one currency expressed in terms of another

How are exchanges rates determined by?

By the interaction of supply and demand

Explain how British pounds and US dollars exchange rate work when buying goods

-Pounds will be supplied by people who want to sell GBP to purchase USD so they can buy goods and services from the USA or invest in the USA

-Pounds will be demanded by people in USA who want to buy GBP to purchase goods and services from the Uk or invest here.

What may cause a currency appreciation?

A right shift in demand for the currency and also will lead to increases in qty of current traded.

-Also a left shift in supply of currency so less of it traded but will start cause the currency to appreciate

-E.g g. One GBP is now worth more USD. British people and firms will pay less GBP for their goods and services bought in the US. However, US people and firms will pay more for their British goods and services.

What causes a Currency depreciation?

-A right shift in supply will lead to an increase in the number of pounds traded but a decreases in the value of pound

-Also a left shift in demand will lead to less pounds being traded and a lower price for the pound

E.g One GBP is now worth less USD. British people and firms will pay more GBP for their goods and services bought in the US. However, US people and firms will pay less for their British goods and services.

Who Demand Pounds?

-People who want to buy Uk goods and services

-People who want to invest in Uk bank accounts to earn interest

-People who want to invest in Uk

-People who speculate that the value of the pound will rise to profit

How does Uk exports affect the demand for the pound?

If UK exports become more desirable because of a gained reputation for quality then a lot of people in other countries will demand pounds (Right shift of demand). Also if Uk improves worker productivity or has lower inflation than other countries these could reduce costs and allow for lower prices. Increasing demand for pound. Also if average incomes in other countries rise, they have more to spend and this may mean more demand for our exports so more demand for pound. If they are less desirable then demand for pounds will fall (Left shift of demand

How does Interest rates affect the demand for Currency?

If the interest rate in the UK is higher than the interest rate elsewhere then foreign people will want to buy pounds to deposit in UK banks and make more interest (Right shift of demand).

How does Uk changing taxes/workers productivity affect demand for currency?

If the Uk reduces corporate tax rate so firms keep more of their profit, it may attract more international investments increasing demand for pound.

-If uk workers become more productive then firms can expect lower average costs and this may attract more firms to invest in Uk increasing demand for pound

How do Speculators affect demand for currency?

If speculators oversease think the value of the pound will rise they may buy it now to sell it later for profit (Right shift of demand).

Who supplies pounds?

People who want to:

-Buy foreign goods and services

-Invest in foreign bank accounts to earn interest

-Invest in the foreign countries

-Speculate that the value of the pound will fall against another currency.

How does Uk imports affect the supply of currency?

-An increased in demand for foreign goods and services may come about if foreign goods are seen as more desirable because of a gained reputation for quality meaning pounds will be sold to import goods and supply will increase.

-Also if foreign counties improve worker productivity or have lower inflation than the Uk, these could reduce the costs and allow for lower prices. This makes Uk consumers import more goods and to do this they’ll have to sell their pound. Increasing the supply of the pound

-If the average incomes in the Uk increase, people have more to spend and this may mean greater demand for foreign imports. This means they’ll have to sell their pound, increasing the supply.

How does interest rates affect the supply of a currency?

If the interest rate in the UK is lower than the interest rate elsewhere then UK people will want to buy foreign currency to deposit in overseas banks and make more interest (Right shift of supply).

How does foreign countries changing taxes/workers becoming more productive affect the supply of the pound m?

-If the foreign counties reduce their corporate tax rate so firms keep more of their profits, it may attract Uk firms to invest here.They would have to sell their pound which increases the supply of the pound

-If the foreign workers become more productive then firms can expect lower average costs and thus may attract more uk firms to invest there. So Uk investors will have to sell their pound, increasing the supply of pound.

How do speculators affect the supply of the pound?

If speculators in the UK think the value of the pound will likely fall against another currency they might buy that currency now and sell it back for more pounds later (Right shift of supply).

How does domestic incomes affect the supply of the pound?

If domestic incomes rise people may be able to afford more foreign goods and services (Right shift of supply). If they fall then people will buy less imported goods and services (Left shift of supply).

What are the effects of rising exchange rates?

1)Rising exchange rate means exports are more expensive so they’ll be less demand for goods.This means you don’t have to produce much products so less output. This means less workers needed so lower employment

2)Lower demand for our products which means prices are lower so lower inflation

3)Cheaper foreign inputs

4)A current account deficit as they’ll be less exports and more imports..

Explain the effects of rising exchange rate for consumers

-Imports-Consumers will benefit from cheaper imported goods which could mean better quality goods and a wider selection at a better price. This means consumers will have more disposable income and better quality of life

-Travel-Cheaper for Uk residents to travel as they’ll get more for their pound on holidays so they’ll have a great time

-Interest rates-Consumers with mortgages or those who wish to get one may benefit from lower rates and be left more disposable income because the Bank of England lowers rates to try to encourage investment to improve the UK's competitiveness and to encourage spending

-Lower inflation-Consumers benefit from the certainty of lower inflation because lower exports and higher imports means less overall demand in the country reducing demand pull inflation.

Explain the effects of fall in exchange rate on consumers

-Imports-Imports become more expensive and consumers won’t be to afford as much as before. This means for many spoke there will be less choices of goods and higher prices.This means less disposable income and lower quality life.

-Travel-More expensive to travel for Uk consumers travelling abroad as it will cost them more pounds

-Interest rate- There’s more demand for our products and this means higher inflation. This means lower income and could mean Bank of England will raise interest rate to reduce inflation.This will affect those that need to borrow money and those that have mortgages.

Explain the effect of rising exchange rates on producers

-Imports-Producers who import supplies for their production will benefit from lower costs which may mean they can lower prices and be more competitive.

-Travel-For firms that work in the travel industry that sell overseas holidays will see an increase in demand as cost of holidays go down

-Lower inflation-means less pressure on wages which in time can help keep firms cost down

-Lower interest rates-Producers who wish to expand and benefit from economies of scale so they can become more competitive benefit from these lower interest rates too as they can borrow to invest and expand.

How does Fall in exchange rates affect producers?

imports-It’s more expensive now for raw materials and components

Travel-Of firms that are part of the uk hospitality and tourism sector will see as bonus as people from overseas are willing to travel to uk as it’s cheaper

-Higher inflation-Increased cost for Uk firms due to this high inflation and decreases international competitiveness

-Higher interest rates-Prevents firms from investing and expanding and take advantage of economies of scale