Exchange Rate Fluctuations and Business Competitiveness
An exchange rate is the price of one currency expressed in terms of another, e.g. how many US dollars one pound sterling (GBP) buys. Exchange rates constantly fluctuate.
Before you start
Make sure you're comfortable with these topics first:
Method
- Identify whether the pound is appreciating, strengthening and buying more foreign currency, or depreciating, weakening and buying less foreign currency.
- Identify whether the business in the case is an importer, buying goods or materials priced in a foreign currency, or an exporter, selling goods priced in pounds, or receiving foreign currency, to overseas customers, since the two are affected oppositely.
- Learn the rule and do not mix it up: appreciation helps importers, imports get cheaper, and hurts exporters, exports become less price-competitive abroad; depreciation helps exporters, exports become more price-competitive, and hurts importers, imports get more expensive.
- To work through the arithmetic, convert the same foreign-currency amount into pounds at the old exchange rate and the new exchange rate, and compare: divide the foreign-currency figure by the exchange rate to find the pound value, then compare the figure before and after the rate moved.
- For explain questions, state the direction of the exchange rate movement, apply the correct import or export rule, and give the resulting effect on cost, price, or competitiveness, always naming which side of the transaction the business is on.
- For evaluate questions on how a business should respond to exchange rate movements, consider options such as absorbing the cost, raising or lowering prices, finding a domestic supplier or a new export market, or hedging, fixing a future exchange rate in advance, against detail from the case.
- Do not quote a real current GBP exchange rate as fact; where an exam or a revision answer needs a number, treat it as an illustrative example only and focus on getting the direction of the effect right.
Worked example
Suppose the exchange rate is 1 pound = 1.30 US dollars. Hartley Exports sells machinery parts to a US customer for a fixed price of 13,000 US dollars per order, and converts every dollar payment it receives back into pounds. The pound then appreciates, and the exchange rate moves to 1 pound = 1.50 US dollars. Calculate the change in the pound value of one 13,000 dollar order, and explain what this means for Hartley Exports.
- Calculate the pound value of the order at the original rate: 13,000 divided by 1.30 equals 10,000 pounds.
- Calculate the pound value of the same 13,000 dollar order at the new rate: 13,000 divided by 1.50 equals 8,666.67 pounds, to the nearest penny.
- Compare the two figures: the order is now worth 8,666.67 pounds instead of 10,000 pounds, a fall of 1,333.33 pounds, even though the US customer still paid exactly 13,000 dollars.
- Explain why: the pound has appreciated, so each dollar Hartley receives now converts into fewer pounds than before, reducing the pound value of every dollar sale.
- Explain the wider effect: to keep receiving 10,000 pounds per order after the appreciation, Hartley would have to raise its dollar price to the US customer, which makes its machinery parts more expensive and less price-competitive against local US or other overseas suppliers.
- Write the concluding point: this shows why an appreciating pound reduces UK exporters' competitiveness, either through lower pound revenue on unchanged foreign prices, or through having to raise foreign prices and risk losing customers.
Practice questions
Try each question, then tap to reveal the answer.
Q1Define exchange rate.Show answer
Answer: The price of one currency expressed in terms of another currency.
Q2State what it means when the pound appreciates.Show answer
Answer: The pound strengthens, or rises in value, so one pound buys more units of a foreign currency than before.
Q3State what it means when the pound depreciates.Show answer
Answer: The pound weakens, or falls in value, so one pound buys fewer units of a foreign currency than before.
Q4State the effect of an appreciating pound on the cost of imports to a UK business.Show answer
Answer: Imports become cheaper, since the pound buys more foreign currency for the same amount of pounds.
Q5State the effect of a depreciating pound on UK exporters' price competitiveness abroad.Show answer
Answer: It improves it, since UK goods become cheaper for foreign buyers to purchase in their own currency.
Q6If the exchange rate is 1 pound = 1.20 euros and a UK business imports goods costing 6,000 euros, calculate the cost in pounds.Show answer
Answer: 6,000 divided by 1.20 = 5,000 pounds.
Q7Using the same order, if the pound then depreciates to 1 pound = 1.00 euro, calculate the new cost in pounds and state whether the importer is better or worse off.Show answer
Answer: 6,000 divided by 1.00 = 6,000 pounds; the importer is worse off, paying 1,000 pounds more for the same order.
Exam-style questions
Written in the style of a GCSE Business exam paper, with a full mark scheme.
The exchange rate moves from 1 pound = 9.00 South African rand to 1 pound = 11.00 South African rand. A UK business imports fruit priced at 4,400 rand per shipment. Calculate the change in the pound cost of one shipment, and state whether this change benefits or harms the UK importer.
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Millbrook Wine imports wine from France, paying in euros, and also exports a small range of English sparkling wine to Germany, priced in euros. The pound has been steadily depreciating against the euro for six months. Evaluate the likely overall impact of this depreciation on Millbrook Wine.
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