Summary AQA A-level Economics: Exchange Rates and Exchange Rate Systems Notes

Exchange Rates and Exchange Rate Systems:

Y1:
Exchange Rate: The price of one currency in terms of another.
(Price of £1 = $1.60)

Diagram:
On x- axis Price of Currency in Market for currency (e.g Price of £ in $)
On y- axis Quanity of Market Currency (Q of $)




P1 = The Exchange Rate of Currency
(P1 - £1=$1.60)

What Determines Demand For Currency?
DEMAND INCREASE - Currency Appreciates
Foreigners demand more of currency (Take pound as Example)
1) Increase in relative Intrest rates - Foreigners think home country is best to
put money in - Higher rate of return - demand for pound increases
2) Speculation anticipate rise - Traders think that pound will appreciate - buy/
more pounds - increase demand for pounds.

, 3) Increase in FDI - Foreign firms set up in home country - must convert into
new currency (pounds) - to but all equipment/pay workers- demand for
pound increases
4) Incomes Abroad - If foreigners income rises - demand for exports rises -
must buy exports in pounds(home currency) - demand for pounds rises.
5) Increase in International Competitiveness - Make exports more competitive
- more exports sold - people have to buy in dometic currency(pounds) -
demand for pounds rises.
Diagram for Increase in demand for Currency:




What Determines Supply Of Currency?
SUPPLY INCREASES - Currency Depreciates
Forigners demand LESS of currency (take pound as example)

1) Decrease in Interest Rates - Foreigners think UK is not best to put money
in - Lower rate of return - People exchange pound for other currencies.
(money moved away) - Supply of £ in other currency Increases.
2) Speculation anticipate fall in Currency - Traders Sell pound/short pound -
buy more of other currency - Supply of £ in other currency Increases.

, 3) Firms moving away from country (opposite of FDI) - Firms leave country -
exchange pounds for another currency - Supply of £ in other currency
Increases.
4) Increase in Dometic Incomes - Demand for imports rise - must buy in
another currency - exchanging point into another currency Supply of £ in
other currency Increases.
Diagram for Increase in Supply for Currency:




Exchange Rate Impacts:
Strong Currency:
SPICED
Strong pound imports cheaper exports dearer

- Demand for Imports rises - Import expenditure Rises
- Demand for Exports falls - Export Revenue Falls
AD FALLS (Imports rises, exports fall)
Imports Cheaper - Raw Material Costs Fall - Costs of Production Fall - SRAS
shifts Right - Cost Push Inflation Falls.
Diagram for Strong Currency: