Understanding Exchange Rates: Basics and Effective Exchange Rates

This video tutorial covers the basics of exchange rates, including the demand and supply curves for foreign currency, and how exchange rates are determined. It explores factors affecting exchange rate changes, such as inflation, interest rates, and speculation. The video also explains effective exchange rates and their calculation based on trade weightings.

What is the primary reason consumers and firms in another country demand sterling?

• To invest in the UK or buy UK goods and services

• To pay UK taxes

• To travel to the UK

• To save in UK banks

How does a decrease in the exchange rate from £1.00 = $2.00 to £1.00 = $1.00 affect the demand for Rolls Royce cars in the US?

• Demand decreases because cars become more expensive

• Demand increases because cars become cheaper

• Demand decreases because of higher taxes

• Demand remains unchanged

What happens to the quantity supplied of sterling when the price of a Mac Air increases from £750 to £1500?

• It remains the same

• It increases

• It fluctuates randomly

• It decreases

What determines the exchange rate in the context of demand and supply?

• The government

• Where demand equals supply

• International treaties

• The central bank

Which factor is likely to cause a depreciation in the exchange rate?

• High inflation relative to other countries

• Rising interest rates

• Increased foreign investment

• A strong credit rating

What is a key factor that can lead to an appreciation of the exchange rate?

• Low inflation relative to other countries

• A declining credit rating

• Decreased foreign investment

• High inflation in the UK

How do expectations and speculation influence exchange rates?

• They only affect long-term rates

• They can cause fluctuations based on anticipated changes

• They stabilize exchange rates

• They have no effect

What is an effective exchange rate?

• The rate for currency conversion at airports

• The rate used for international loans

• An index measuring average exchange rate movements

• The rate set by the government

How is the effective exchange rate index calculated?

• By averaging all exchange rates equally

• By weighting exchange rates based on trade value with main partners

• By using the highest exchange rate available

• By considering only the US dollar

What impact does a change in the effective exchange rate have?

• It only affects government policies

• It influences trading outcomes and relative prices

• It has no impact on trade

• It affects only domestic prices