Find out from John Birchall what's going on in the Business world
Sterling was down three cents against the dollar at $1.4633, and down 2.6 cents against the euro at 1.1478 Euros. The markets are concerned that a weak government might be unable to reduce the UK's high budget deficit quickly. However, ratings agency Moody's said the outcome of the election would have no bearing on the UK's credit rating. Business is also watching exchange rate markets as the fall in the value of the pound may cause exports to struggle and imports to rise in price.
A bit of revision
Exchange Rates
Exchange rates are the price of one currency in terms of another. They are mainly determined by the supply and demand for the currency.
Why do we demand a currency?
Well it is needed when you engage in foreign trade or you want to invest in a country. You sell your own currency and buy that which you want to use.
What influences the supply of a currency?
Those wanting to buy your products or invest in your country need to buy your currency in order to do these. They sell their currency for yours.
What determines an exchange rate?
It's the demand for that currency, which is influenced by interest rates, the desire to invest in that country and the desire of others to buy goods made in your country. The supply is determined by government policy, how much national have been selling to buy other currencies and the amount sold by those no longer keen to invest in your currency e.g. higher demand for the currency (perhaps from increased exports or greater capital inflows) will lead to a higher exchange rate.
Exchange rate and import and export price changes
When the exchange rate changes this means a change in export and import prices. These can be summarised as:
Appreciation in exchange rate - export prices rise, import prices fall
Depreciation in exchange rate - export prices fall, import prices rise.
If you have problem remembering this then simply try a simple example in your head. For example, if the exchange rate between sterling and the dollar is £1=$2, then a £5 export from the UK will sell in the US for $10. If the exchange rate falls to £1=$1 then the export price falls to $5 (though the firm still gets £5). So, depreciation in exchange rate = decrease in export prices. All the rest follows from there.
What happens when export prices rise?
Well, you might have to absorb any price increase and so reduce your profit margins. Much will depend on the price elasticity of the product. If it's inelastic then sales should not drop that much, whilst if it's elastic sales will fall and serious decisions will have to be made.
What happens if import prices fall?
This might reduce national prices, especially if the imports are components of other products (in which case costs have fallen). However, if imports become cheaper then local equivalents might struggle - especially if price is important in consumer's decisions. Always remember that goods need to be competitive both on price and non-price factors.
So, exchange rates and their fluctuations can influence business. Movements in rates mean:
• Uncertainty and difficulty in planning
• Problems in overseas markets
• The need to buy on spot or future markets
• Costs of changing catalogues etc
Some other resources when working on exchange rates
http://www.tes.co.uk/article.aspx?storycode=6039251 – good resource to use, especially with younger students.
http://econ.unimelb.edu.au/TLdevelopment/school2.htm - University of Melbourne, Australia but useful for other ideas and teaching methods
http://www.bized.co.uk/learn/economics/international/exchange/index.htm