Exchange Rate Appreciation (Edexcel IGCSE Economics)

Revision Note

Author

Steve Vorster

Expertise

Economics & Business Subject Lead

Appreciation (Revaluation)

Appreciation occurs in a floating exchange rate system
- If there is excess demand for the currency on the FOREX, the price rises (the currency is worth more/is more expensive to buy)
- An appreciating exchange rates is also known as strengthening exchange rate, or revaluation
Different currencies can be bought and sold, just like any other product
The forces of demand and supply determine the rate at which one currency exchanges for another
If there is excess demand for the currency on the FOREX market, then price rises (the currency appreciates)
If the supply of the currency decreases, this can also result in an appreciation

The relationship between the US$ and the Euro shows that as Europeans demand the $ it appreciates — **The market for US$ in Euros shows an increase in European demand for $**

Diagram analysis

The initial exchange rate equilibrium for Euro/US$ is found at P₁Q₁
When Europeans visit the USA, they demand US$
- The increased demand for the US$ shifts the demand curve to the right
- This results in the value of the $ appreciating from P₁ → P₂
- A new market equilibrium forms at P₂Q₂

Impact of Appreciation on the Current Account

The relationship between the current account on the balance of payments and the exchange rate is dynamic
- Changes in the exchange rate will change the price of imports and exports

Impact of Appreciation on Exports, Imports (Current Account)

Impact	Explanation
Exports	An appreciating (strengthening) exchange rate makes exports more expensive Foreigners have to exchange more of their own currency to buy the exports, making the exports seem more expensive for foreign buyers, potentially leading to a decrease in export volumes
Imports	A stronger exchange rate makes imports cheaper Imports become relatively cheaper for domestic consumers, which may lead to an increase in import volumes
Current account	Domestic consumers may switch demand to foreign goods and as imports rise, the balance on the current account worsens The decease in export volumes will also worsen the current account balance

Worked Example

The USA imports most of its olive oil from Spain, Italy and Portugal in Europe, and is the largest olive oil importer in the world.

Which one of the following best describes the effect of an appreciation of the US dollar against the European Euro?

A. There will be an increase in US imports of European olive oil and the US current account will improve

B. There will be a decrease in employment in European olive fruit pickers and the US current account will worsen

C. There will be an increase in employment in European olive fruit pickers and US imports of European olive oil will decline

D. There will be an increase in US imports of European olive oil and the US current account will worsen

D is the correct answer

The appreciation of the dollar will reduce the relative price of European olive oil, increasing imports and therefore worsening the US current account balance

A is incorrect, as the increased imports of olive oil will increase the flow of US Dollars out of the US, thereby worsening the current account

B is incorrect, as there is likely to be an increase in the employment in European olive fruit pickers

C is incorrect, as the price of European olive oil will become cheaper, therefore imports will increase, not decline

You've read 0 of your 10 free revision notes

Unlock more, it's free!

Join the 100,000+ Students that ❤️ Save My Exams

the (exam) results speak for themselves:

Next topic

Did this page help you?