Pearson Edexcel · A-Level · Economics B
Course version: 9EB0 · Version from Sept 2015
Exchange rates: a) Changes in exchange rates
An exchange rate is the price of one currency expressed in terms of another.
Checked against the Pearson Edexcel 9EB0 specification (opens in a new tab) on .
- Point 1 of 4
- 4 key terms
Study notes
From the checked teaching notes for this specification point.
The idea
An exchange rate is the price of one currency expressed in terms of another. Changes in exchange rates occur due to shifts in the supply and demand for a currency on the foreign exchange market. Factors causing these shifts include changes in interest rates, inflation rates, economic growth, and speculation. For example, if the Bank of England raises interest rates, hot money flows into the UK, increasing demand for the pound and causing it to appreciate. Conversely, if UK inflation is higher than its trading partners, UK exports become less competitive, reducing demand for the pound and causing it to depreciate.
What earns the marks
- Define exchange rate as the value of one currency expressed in terms of another.
- Identify factors causing currency appreciation, such as higher interest rates or strong economic growth.
- Identify factors causing currency depreciation, such as high relative inflation or a current account deficit.
- Calculate the new value of a currency following a percentage change in the exchange rate.
- Explain the role of speculation and hot money flows in determining short-term exchange rate movements.
Common mistakes and how to put them right
Confusing appreciation and depreciation.
Put it right: Appreciation means the currency buys more foreign currency; depreciation means it buys less.
Assuming a strong currency is always beneficial for an economy.
Put it right: A strong currency makes exports more expensive and imports cheaper, which can worsen the current account deficit.
Calculating currency conversions incorrectly by multiplying instead of dividing.
Put it right: Convert domestic to foreign currency, multiply by the exchange rate; to convert foreign to domestic, divide by the exchange rate.
Exam tips
- Always double-check your calculations when converting currencies, ensuring you are using the correct mathematical operation.
- Use the acronym SPICED (Strong Pound Imports Cheap Exports Dear) to remember the effects of an appreciation.
- When analysing exchange rate changes, consider both the short-term effects like hot money flows and long-term effects like trade balances.
Try the lesson
The start of the Exchange rates: a) Changes in exchange rates lesson, made from checked teaching notes for this specification point.
Have a go first
If the value of the British pound (£) changes from £1 = 1.25 to £1 =1.40, what has happened to the pound and what is the likely effect on UK export prices in the US?
Listen
An exchange rate is the price of one currency expressed in terms of another. Changes in exchange rates occur due to shifts in the supply and demand for a currency on the foreign exchange market. Factors causing these shifts include changes in interest rates, inflation rates, economic growth, and speculation. For example, if the Bank of England raises interest rates, hot money flows into the UK, increasing demand for the pound and causing it to appreciate. Conversely, if UK inflation is higher than its trading partners, UK exports become less competitive, reducing demand for the pound and causing it to depreciate. A strong answer earns marks for these points. Define exchange rate as the value of one currency expressed in terms of another. Identify factors causing currency appreciation, such as higher interest rates or strong economic growth. Identify factors causing currency depreciation, such as high relative inflation or a current account deficit. Calculate the new value of a currency following a percentage change in the exchange rate. A common slip: Confusing appreciation and depreciation. Instead, Appreciation means the currency buys more foreign currency; depreciation means it buys less. Exam tip: Always double-check your calculations when converting currencies, ensuring you are using the correct mathematical operation.
See it
Key words
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Exchange rate
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Appreciation
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Depreciation
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Hot money flows
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See every definition
- Exchange rate
- The price of one currency expressed in terms of another.
- Appreciation
- A rise in a currency's value so that it buys more foreign currency, caused for example by higher interest rates bringing in hot money flows.
- Depreciation
- A fall in a currency's value so that it buys less foreign currency, caused for example by high relative inflation making exports less competitive.
- Hot money flows
- Flows of money into a country when its interest rates rise, increasing demand for the currency and causing it to appreciate.
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