Explain what an exchange rate is and how a rise (appreciation) or fall (depreciation) in the currency affects exporters and importers

What this dot point is asking

This outcome wants you to explain what an exchange rate is and how a rise (appreciation) or fall (depreciation) in the currency affects exporters and importers. The central idea is that the exchange rate sets the price of one currency in terms of another, so when it changes, the price of a country's exports and imports changes too - helping one group of businesses while hurting the other.

The answer

What an exchange rate is

An exchange rate is the price of one currency in terms of another - for example, how many US dollars one Singapore dollar buys. Exchange rates change over time with supply and demand for the currency. A useful memory aid is SPICED and WPIDEC:

• Strong Pound (currency) = Imports Cheaper, Exports Dearer (SPICED).
• Weak Pound (currency) = Imports Dearer, Exports Cheaper (WPIDEC).

Appreciation (a stronger currency)

An appreciation is a rise in the currency's value, so it buys more foreign currency. Effects:

• Imports become cheaper - good for importers, who pay less for foreign materials, lowering costs.
• Exports become dearer abroad - bad for exporters, whose goods now cost foreign buyers more, reducing export sales.

Depreciation (a weaker currency)

A depreciation is a fall in the currency's value, so it buys less foreign currency. Effects:

• Exports become cheaper abroad - good for exporters, who win more foreign sales.
• Imports become dearer - bad for importers, who pay more for foreign materials, raising costs.

Why it matters to businesses

Firms that export want a weaker currency (cheaper exports); firms that import want a stronger currency (cheaper imports). Many firms do both - importing materials and exporting finished goods - so the net effect depends on the balance. Exchange-rate changes affect costs, prices, sales and profit, so firms trading abroad must watch the rate and may protect themselves against sudden swings.

Examples in context

Example 1. An exporter helped by a weaker currency. A Singapore manufacturer that sells most of its output overseas benefits when the Singapore dollar depreciates: its goods become cheaper for foreign buyers without changing the home-currency price, so export orders rise. The example shows why exporters prefer a weaker currency, and why a sudden appreciation can squeeze an export-led firm by pricing it out of foreign markets.

Example 2. An importer helped by a stronger currency. A retailer that imports electronics to sell at home gains when the Singapore dollar appreciates, because each dollar buys more foreign currency, so the imported goods cost less. Its costs fall, improving margins or allowing lower prices to customers. The example shows the opposite case to the exporter: importers prefer a stronger currency, which is why the same exchange-rate move helps one firm and hurts another.

Try this

Q1. Define the term exchange rate. [2 marks]

• Cue. An exchange rate is the price of one country's currency in terms of another, for example how much foreign currency one unit of the home currency will buy.

Q2. State whether an appreciation of the currency helps exporters or importers, and why. [2 marks]

• Cue. It helps importers: a stronger currency buys more foreign currency, so imported goods and materials become cheaper, lowering importers' costs (while exports become dearer abroad, hurting exporters).

Q3. Explain how a depreciation of the currency could affect a business that exports its products. [4 marks]

• Cue. A depreciation means the home currency falls in value, so the firm's exports become cheaper for foreign customers even though the home-currency price is unchanged. Cheaper prices abroad make the products more competitive, so foreign demand and export sales are likely to rise, increasing the firm's revenue. The exporter therefore benefits from a weaker currency, though if it imports any materials those would become more expensive, slightly offsetting the gain.