Exchange Rates
Overview
A currency has a price, just like a loaf of bread or a haircut, except the price of a currency is measured in another currency. That price moves every day in the foreign exchange market, driven by the same forces of supply and demand you have met elsewhere in economics, and it changes what every importer, exporter and traveller pays.
In this lesson you will learn how exchange rates are determined, what makes a currency appreciate or depreciate, and how those movements ripple through to the prices of exports and imports and, ultimately, to a country's current account on the balance of payments.
Objectives
- Definition of exchange rates
- Factors affecting supply and demand of currencies: interest rates, currency speculators, imports and exports of goods and services, supply and demand diagrams to show determination of exchange rates
- Definition of appreciation: definition of revaluation, impact of appreciation of exchange rate on import and export prices, demand for imports and exports, current account on balance of payments
- Definition of depreciation: definition of devaluation, impact of depreciation of exchange rate on import and export prices, demand for imports and exports, current account on balance of payments
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Lesson Note
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Lesson Evaluation
Congratulations on completing the lesson on Exchange Rates. Now that youve explored the key concepts and ideas, its time to put your knowledge to the test. This section offers a variety of practice questions designed to reinforce your understanding and help you gauge your grasp of the material.
You will encounter a mix of question types, including multiple-choice questions, short answer questions, and essay questions. Each question is thoughtfully crafted to assess different aspects of your knowledge and critical thinking skills.
Use this evaluation section as an opportunity to reinforce your understanding of the topic and to identify any areas where you may need additional study. Don't be discouraged by any challenges you encounter; instead, view them as opportunities for growth and improvement.
- An exchange rate is best defined as: A) The rate of interest set by a central bank B) The value of one currency expressed in terms of another C) The rate of inflation in the domestic economy D) The tax rate applied to imports Answer: B
- A rise in a country's interest rates, relative to other countries, is most likely to cause its currency to: A) Depreciate B) Appreciate C) Stay exactly the same D) Be devalued by the government Answer: B
- If the exchange rate changes from 1 GBP = 1.50 USD to 1 GBP = 1.20 USD, the pound has: A) Appreciated B) Depreciated C) Been revalued D) Stayed unchanged Answer: B
- When a currency appreciates, what happens to the price of that country's exports for foreign buyers? A) They become cheaper B) They become more expensive C) They stay exactly the same D) They are no longer traded Answer: B
- A deliberate, one-off increase in a currency's official value, set by a government under a fixed exchange rate, is called: A) Appreciation B) Depreciation C) Revaluation D) Devaluation Answer: C
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