A2 Business Studies – External Influences

Exchange Rates

Exchange Rates

The price of one country’s currency in terms of another

It is determined by the supply and demand of the pound

UK – Pound (£)

US - Dollar ($)

EU- Euro (€) Japan - Yen(¥)

1 1.5131 1.1123 144.4448

Exports - goods sold in foreign markets

Imports - foreign goods brought into the market

Demand for pounds

Caused by:

Desire for UK goods/services Desire to save in the UK (higher interest rates) More tourism in the UK Speculators - believe pound will rise in future so buy now

Higher demand will push pound value up

Supply of pounds

May increase if:

Greater demand for foreign goods Greater desire to save abroad More tourism abroad Speculators believe pound will fall in the future

Higher supply will push value of pound down

AS External Influences

Exchange rate changes

Interest rates and exchange rates

High interest rates attract foreign investment and therefore demand for pounds which pushes the value of the pound up (exchange rate)

Low interest rates do not attract foreign investment and encourage investors to save abroad

£1 = $2

£1 = $1.5

A Rise in Exchange Rates

UK US

$75

$75Average TV price in the US market

£50

$100

UK Manufacturer exporting to the US

A Rise in Exchange Rates

Exporters become less competitive abroad = sales fall

Imports are cheaper compared with home market produced goods

Firms buying imported raw materials reduce costs

£1 = $1

£1 = $1.5

A Fall in Exchange Rates

UK US

$75

$75Average TV price in the US market

£50

$50

UK Manufacturer exporting to the US

A Fall in Exchange Rates

Exports are cheaper abroad and therefore more competitive = sales rise

Imports are more expensive

Firms importing raw materials will see costs rise

Student Activity (10 minutes)

An interest rate rise result in the exchange rate going from £1 = $2 to £1 = $4.

How will this impact on:

A US TV manufacturer selling its goods in the US and in the UK at $100.

A UK TV manufacturer selling its TV for £80

If interest rates drop and the exchange rate changes to £1 = $0.50. How will this impact on the two firms in both markets.

Businesses affected by exchange rates

Businesses that export

Businesses selling goods in the UK competing against foreign imports

Businesses that purchase imported fuel, raw materials and components to produce their goods etc

Effects of an increase in exchange rates

e.g. before £1=$1.50, now £1=$2 Price of exports sold abroad increases and import prices from

abroad fall Price elasticity of goods determines how much their demand

and revenue falls Inelastic goods = less impact on sales, so higher revenue

from more favourable exchange rate Likewise an importing company may get cheaper raw

materials. However, domestic businesses may face cheaper

competition from abroad.

Businesses benefiting from a strong pound.

Will firms increase profit margins or pass the saving onto the consumer with lower prices?

Problems of fluctuating exchange rates

Rate can change from day to day as determined by supply and demand of currency

Importers & exporters will face difficulties in predicting sales and long term planning may not be accurate

Firms have ability to buy futures contracts - insurance that enables them to buy currency in advance at a guaranteed fixed rate. This reduces uncertainty

Fluctuations also make marketing and administration difficult e.g. changing pricing and advertising literature abroad

The effect of exchange rates on different types of business

Exporters - will exchange rate changes impact on good and make them more or less competitive. (availability of substitutes)

UK firms - are foreign firms becoming more competitive in home market?

Firms importing raw materials - will impact on costs

Exchange rates always must be considered when moving into another country. They are a great source of uncertainty.

Student Activity

Complete the questions related to the Jaguar case study.

Exam Style Question

A UK manufacturer selling its goods in the UK and US is facing a lower exchange rate (e.g. £1 = $1.70 rather than $2.00). How will this impact the manufacturer and what might they do about it?