- Define and explain Exchange Rates in your own words
- Use key terms such as exchange rate accurately
- Apply what you have learned to new examples and questions
- Avoid the common mistakes learners make with this topic
This lesson focuses on Exchange Rates: learn how currencies are priced and why they move.
Learn how currencies are priced and why they move.
Key ideas
Exchange rates and competitiveness
If the pound depreciates, UK exports become cheaper abroad and imports dearer at home, which can improve the trade balance (subject to the Marshall–Lerner condition). But depreciation also raises import costs, fuelling inflation — a key dilemma for policymakers.
Protectionism versus free trade
Tariffs and quotas shield domestic jobs and infant industries and can protect national security, but they raise consumer prices, invite retaliation and shelter inefficiency. Globalisation has lifted millions from poverty through trade-led growth, yet created losers in declining industries — hence demands for retraining and compensation.
Key term — exchange rate: The price of one currency in terms of another, e.g. £1 = $1.27. It moves with supply and demand for the currency.
The UK imposes a 10% tariff on imported bicycles priced at £200. Calculate the new price and identify the winners and losers.
Calculate the tariff: 10% of £200 = £20. New price to consumers: £200 + £20 = £220. Winners: domestic bicycle producers (who can raise prices) and the government (tariff revenue). Losers: consumers, who pay £20 more per bicycle.
Answer: The price rises to £220. Domestic firms and the Treasury gain; consumers lose £20 per bicycle.
- Confusing depreciation with devaluation Depreciation is a market-driven fall in a floating currency; devaluation is a deliberate cut in a fixed exchange rate.
- Thinking exports are good and imports bad Imports give consumers choice and lower prices and supply inputs for exporters — a surplus is not automatically better than a deficit.
Practice
They become cheaper in foreign currency, boosting demand for them.
For: protects domestic jobs and infant industries. Against: raises consumer prices and risks retaliation.
Countries gain by specialising in goods they produce at the lowest opportunity cost, then trading.
$63.50 (50 × 1.27).
Quick check
Which of these best defines "exchange rate"?
Why might globalisation increase inequality within a country?
What is a quota?
- Exchange Rates: learn how currencies are priced and why they move.
- Exchange rates and competitiveness: If the pound depreciates, UK exports become cheaper abroad and imports dearer at home, which can improve the trade balance (subject to the Marshall–Lerner condition).
- tariff: A tax on imports that raises their price, protecting domestic producers but hurting consumers.
- Watch out for: confusing depreciation with devaluation