Exchange rates — practice questions

(a) Before: $1.40 \times £20 000 = **$28 000** After: $1.20 \times £20 000 = **$24 000**

The car is $4 000 cheaper for US buyers — UK exports more competitive.

(b) Exports: Lower dollar price should increase quantity demanded of UK cars in the US (assuming demand is not perfectly inelastic).

Imports: Sterling buys fewer dollars, so US goods cost more in £ → import spending may fall.

Net exports (X − M) likely rise → AD increases (ceteris paribus).

Evaluation: Effect depends on PED for exports/imports and whether trading partners retaliate. Short-run volume may lag (J-curve at A Level).

(a) Before appreciation: To find the cost in pounds, we divide the euro price by the exchange rate (€ per £). Cost in £ = Price in € / Exchange Rate Cost in £ = €50,000 / 1.15 = £43,478.26

(b) After appreciation: Using the new exchange rate: Cost in £ = €50,000 / 1.25 = £40,000.00

The appreciation of the pound has made the imported machine £3,478.26 cheaper for the UK company.

(c) Effect on the UK economy: Cheaper imports, such as this machine, reduce production costs for UK firms. This can lead to lower prices for consumers or higher profit margins for the firm, potentially encouraging further investment. This is a positive supply-side effect that can help reduce cost-push inflationary pressure in the economy. However, if the appreciation leads to a significant increase in overall import spending, it could worsen the UK's current account balance (ceteris paribus).