Exchange Rates

Edexcel IGCSE Economics (4EC1) · Section D: The Global Economy

Specification points

• The foreign exchange rate and how it is determined.
• The effects of appreciation and depreciation.

What is an exchange rate?

The exchange rate is the price of one currency in terms of another (e.g. £1 = $1.25). In a floating system it is set by the demand for and supply of the currency on the foreign exchange market.

What changes it?

A currency rises when demand for it rises or supply falls. Causes include high demand for a country's exports, higher interest rates attracting foreign savers, inward investment, and speculation.

Key definitions

Effects of appreciation and depreciation

Use SPICED — Strong Pound, Imports Cheaper, Exports Dearer:

• Appreciation (stronger currency): exports become dearer abroad and imports cheaper → exports may fall, imports may rise.
• Depreciation (weaker currency): exports become cheaper abroad and imports dearer → exports may rise, imports may fall.

Appreciation → dearer exports, cheaper imports. Depreciation → cheaper exports, dearer imports.

Worked example

A country's currency depreciates by 10%. Its exports become cheaper for foreign buyers, so export sales rise, helping firms and jobs. But imported goods and raw materials become more expensive, which can raise costs and inflation at home — so depreciation helps exporters but can push up import prices.

Common exam mistakes

• Getting the effects backwards (appreciation makes exports *dearer*).
• Confusing depreciation (floating) with devaluation (fixed).

Exam technique

State whether the currency has appreciated or depreciated, then use SPICED to explain the effect on exports, imports and the trade balance.

Quick revision

• Exchange rate set by demand and supply of the currency.
• Appreciation → exports dearer, imports cheaper.
• Depreciation → exports cheaper, imports dearer.