appreciation and depreciation of an exchange rate

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Exchange Rates

6.2.4 Appreciation and Depreciation of an Exchange Rate

Exchange rates are the value of one currency in relation to another. These rates can fluctuate, leading to appreciation or depreciation. Understanding these changes is crucial for businesses involved in international trade.

Understanding Appreciation

Appreciation occurs when a currency becomes more valuable compared to another. This means that one unit of the appreciating currency can buy more units of the other currency.

Example: If the exchange rate between the British Pound (GBP) and the US Dollar (USD) changes from $1 = £0.80 to $1 = £0.85, the Pound has appreciated.

Impact of Appreciation on Imports:

  • Imports become cheaper for businesses using the appreciating currency.
  • This can increase competitiveness.

Impact of Appreciation on Exports:

  • Exports become more expensive for buyers using the appreciating currency.
  • This can decrease competitiveness.

Understanding Depreciation

Depreciation happens when a currency becomes less valuable compared to another. One unit of the depreciating currency can buy fewer units of the other currency.

Example: If the exchange rate between the Euro (EUR) and the US Dollar (USD) changes from $1 = Ôé¼1.10 to $1 = Ôé¼1.00, the Euro has depreciated.

Impact of Depreciation on Imports:

  • Imports become more expensive for businesses using the depreciating currency.
  • This can reduce competitiveness.

Impact of Depreciation on Exports:

  • Exports become cheaper for buyers using the depreciating currency.
  • This can increase competitiveness.

Calculating Appreciation and Depreciation

The change in exchange rate is calculated as follows:

Change in Exchange Rate = (New Exchange Rate - Old Exchange Rate)

Percentage Change in Exchange Rate = $$ \frac{(New Exchange Rate - Old Exchange Rate)}{Old Exchange Rate} \times 100 $$

Table Summarizing Appreciation and Depreciation

Currency Exchange Rate (Old) Exchange Rate (New) Change Type of Change Impact on Imports Impact on Exports
British Pound (GBP) $1 = £0.80 $1 = £0.85 £0.05 Appreciation Imports become cheaper Exports become more expensive
Euro (EUR) $1 = Ôé¼1.10 $1 = Ôé¼1.00 Ôé¼0.10 Depreciation Imports become more expensive Exports become cheaper

Suggested diagram: A simple line graph showing the exchange rate over time, with labels indicating periods of appreciation and depreciation.