By market forces- supply and demans. Currencies can be bought and sold like commodities on foreign exchange markets.
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What factors affect the demand for a currency?
Demand for exports and inward FDI; interest rates (higher IRs, more savers, more demand for £); speculation (if in favour, higher demand).
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What factors affect the supply of a currency?
Demand for imports and outward FDI; IRs in other countries (money in other banks, must buy currency with £, supply increases); speculation (decide to sell- higher supply).
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Why do exchange rates change?
Because they are determined by market forces, and at any time supply and demand can change.
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What occurs when exchange rates fall/rise?
Fall- depreciation; lower export prices and so increased demand; higher import prices and so lower demand. Rise- has appreciated; higher export prices and so lower demand; lower import prices and so higher demand.
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How can the government reduce a BoP deficit using exchange rates?
Devaluation- price of exports will fall and price of imports will rise. Change interest rates- however gov may not have control over the rate; may cause inflation if reduced.
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Examine the effect of price elasticity on the effectiveness of the government's exchange rate policy.
Effectiveness of ER policy depends on PED for imports and exports. A BoP deficit will only be reduced if the demand for imports AND exports is elastic.
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Other cards in this set
Card 2
Front
How are exchange rates determined?
Back
By market forces- supply and demans. Currencies can be bought and sold like commodities on foreign exchange markets.
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