What is an exchange rate, and how do changes in it affect consumers and producers?
What an exchange rate is, how to convert between currencies, and how a rise or fall in the exchange rate affects exporters, importers and consumers.
An OCR J205 answer on exchange rates: what an exchange rate is, how to convert between currencies, and how an appreciation or depreciation affects exporters, importers and consumers (the SPICED and WPIDEC effects).
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What this dot point is asking
OCR wants you to explain what an exchange rate is, convert between currencies using one, and explain how a rise or fall in the exchange rate affects exporters, importers and consumers. This is one of the quantitative skills the J205/02 paper rewards, so you must be able to do the calculation and interpret the result.
What an exchange rate is
A rise in the pound's value is an appreciation; a fall is a depreciation. At GCSE you do not need to draw a foreign exchange diagram, but you must understand which way demand and supply push the rate, and what a change means for trade.
Converting between currencies
For example, at \pounds 1 = \1.40\pounds 20{,}00020{,}000 \times 1.40 = \. Going the other way, a US good priced at \7070 \div 1.40 = \pounds 50$.
How exchange rate changes affect exporters and consumers
The effect of a change runs through the price of exports and imports. Two memory aids capture it:
- SPICED: Strong Pound, Imports Cheaper, Exports Dearer. An appreciation makes UK exports more expensive abroad (bad for exporters) but imports cheaper at home (good for consumers buying imports, and it helps lower inflation).
- WPIDEC: Weaker Pound, Imports Dearer, Exports Cheaper. A depreciation makes UK exports cheaper abroad (good for exporters) but imports dearer at home (worse for import-buying consumers, and it can raise inflation).
So a change in the exchange rate creates winners and losers: a weaker pound helps exporters and the tourism industry but raises living costs through dearer imports; a stronger pound helps consumers and importers but makes life harder for exporters.
Try this
Q1. The exchange rate is \pounds 1 = \1.60\pounds 250$. [2 marks]
- Cue. Multiply: 250 \times 1.60 = \400$.
Q2. Explain one effect of an appreciation of the pound on UK exporters. [3 marks]
- Cue. A stronger pound (SPICED) makes UK exports dearer abroad, so foreign demand for them falls and exporters become less competitive, which can reduce their sales and revenue.
Exam-style practice questions
Practice questions written in the style of OCR exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
OCR J205/02 20193 marksThe exchange rate is \pounds 1 = \1.25\ in the United States.Show worked answer →
A Calculate question on currency conversion. To convert dollars into pounds, divide by the exchange rate: \500 \div 1.25 = \pounds 400$.
Markers reward the correct method (dividing the dollar price by the number of dollars per pound) and the answer of . A common slip is to multiply instead of divide; multiplying only works when converting from pounds into dollars.
OCR J205/02 20226 marksThe pound falls from \pounds 1 = \1.50\pounds 1 = \. Explain the likely effects of this fall on UK exporters and on UK consumers who buy imports.Show worked answer →
A 6 mark question linking a depreciation to consumers and producers.
A fall in the pound is a depreciation. Use WPIDEC: Weaker Pound, Imports Dearer, Exports Cheaper. A UK export priced at now costs an American 1000 \times 1.20 = \1200\, so it is cheaper abroad: UK exporters should sell more and become more competitive.
For UK consumers buying imports the opposite holds: imported goods priced in dollars now cost more in pounds, so the price of imports rises, which can also raise inflation. Markers reward the cheaper-exports effect (good for exporters), the dearer-imports effect (bad for import-buying consumers), and ideally a supporting calculation.
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Sources & how we know this
- OCR GCSE (9-1) Economics J205 specification — OCR (2017)