Macro 21 - Exchange rates

Question 1

Define exchange rates?

Answer 1

The price of one currency in terms of another.

Question 2

what does an increase in the value of pound mean?

Answer 2

One pound buys more of a foreign currency. More of a foreign currency is needed to buy one pound.
This is called appreciation.

Question 3

What does a decrease in the value of pound mean?

Answer 3

One pound buys less of a foreign currency. Less of a foreign currency is needed to buy one pound.
This is called depreciation.

Question 4

what are the 3 types of exchange rate systems?

Answer 4

1. Floating exchange rates - leave to free market.
2. Fixed exchange rates - fixed rate.
3. Managed exchange rate system (mix of both) - value of the currency is kept in a range against another currency .

Question 5

define floating exchange rate?

Answer 5

Where the price of two currencies are determined by market forces.

Question 6

What type of exchange rate system does the UK operate?

Answer 6

Floating exchange rates.

Question 7

How can you show appreciation of the value of the pound on a diagram?

Answer 7

Question 8

What are the 4 factors affecting exchange rates?

Answer 8

1. demand for imports and exports.
2. flows of hot money.
3. speculation on the currency.
4. inward investment.

Question 9

Explain “demand for exports and imports” as a factor affecting exchange rates

Answer 9

If a country runs a CA surplus, they are likely to see their currency appreciate over time as money flows into the country. This increases demand for the currency.
Opposite for CA deficit.

Question 10

Explain “flows of hot money” as a factor affecting exchange rates

Answer 10

High interest rates are likely to lead to appreciation of the currency as money flows into financial institutes and banks.

Question 11

Explain “speculation of the currency” as a factor affecting exchange rates

Answer 11

If speculators believe the sterling will rise in the future, they will demand more now to be able to make a profit. This increase in demand will cause the value to rise. If markets see news which makes an interest rate increase more likely, the value of the pound will probably rise in anticipation.

Question 12

Explain “inward investment” as a factor affecting exchange rates

Answer 12

A country that attracts investors will see a large increase in the demand for its currencies.

Question 13

Labels for diagram of exchange rates.

Answer 13

x-axis: quantity of pound traded.
y-axis: Price of pound to dollar.

Question 14

how can a fall in the value of pound be shown on a diagram?

Answer 14

Shift AD to the left.

Question 15

How can an increase in the value of the pound be shown on a diagram?

Answer 15

Shift demand to the right.

Question 16

What will be the impacts on economic objectives if there is an appreciation in the Pound?

Answer 16

Growth - Fall in growth and exports become less competitive, net exports is a component of AD.

Unemployment - Increases, labour is a form of derived demand.

CA - Deteriorates.

Inflation - Decreases. Demand pull and cost push inflation will fall.