0264 · 6.2.4Exchange rates

Exchange rates and currency movements

0:00A stronger currency can make imported electronic components cheaper while making furniture harder to sell abroad. The same change creates an opportunity for one business and a problem for another. The difference comes from who pays, which currency they use, and whether prices change. By the end, you will understand how currency movements affect business costs, selling prices and competition. An exchange rate is the price of one currency in terms of another currency.

0:25A currency is the money used in a country. When businesses trade internationally, payments often involve exchanging domestic money for foreign money. The exchange rate determines how much foreign currency a given amount of domestic money can buy. Imports are goods and services bought from other countries, while exports are goods and services sold to other countries. Goods are physical products, while services are activities carried out for customers. A business can buy from overseas suppliers, sell to foreign customers, or do both.

0:54The domestic currency is the money used in the business’s own country. Foreign currency belongs to another country. Keep that viewpoint fixed throughout an explanation, because the effect depends on whose money changes in value. Our examples describe movements in the domestic currency against the currencies used by suppliers and customers. Appreciation is a rise in the value of a currency against other currencies. After appreciation, the same amount of domestic money buys more foreign currency.

1:20Think of domestic money as having greater buying power overseas. This helps explain why purchases from foreign suppliers can become cheaper for an importing business. Depreciation is a fall in the value of a currency against other currencies. The same amount of domestic money now buys less foreign currency. An importer therefore needs more domestic money to pay an unchanged foreign bill. For overseas customers, however, products priced in the weaker domestic currency become cheaper.

1:45To trace the effects clearly, we initially assume that suppliers keep their prices unchanged in their own currencies. Exporting businesses also keep their domestic selling prices unchanged. These conditions let us isolate the effect of the currency movement. Afterwards, we can examine how managers might change their prices in response.

Import costs and competitiveness

2:04Foxglove Circuits assembles electronic security alarms using imported components. Its overseas supplier charges in foreign currency, and the price of each delivery stays unchanged. Following appreciation, Foxglove needs less domestic money to pay that bill. The components therefore cost the business less in its own currency. Revenue is the income a business receives from selling goods or services. Profit is total revenue minus total costs. If Foxglove’s revenue and other costs remain unchanged, cheaper components increase its profit.

2:33Alternatively, managers could pass some of the saving to buyers by reducing alarm prices. Competitiveness is how well a business’s products attract buyers when compared with rival products, for example on price or quality. A lower selling price improves price competitiveness when customers compare similar products. Foxglove could therefore use its cost saving to make its alarms more attractive. Whether sales increase also depends on customers’ preferences and the alternatives available.

3:00Depreciation reverses the pressure on this importer because the foreign supplier’s bill requires more domestic money. Foxglove’s component costs rise, so unchanged selling prices leave less profit if sales volume and other costs stay constant. Raising prices could help cover the increase. Customers might then choose cheaper alternatives, which could reduce the number of alarms sold.

Export prices and foreign demand

3:20Ravensdale Joinery makes wooden tables and sells them to foreign customers. All its materials come from domestic suppliers, and its production costs remain unchanged in our example. The business keeps its selling price fixed in domestic currency. We can now work through how appreciation affects its overseas sales. Start with the buyer’s payment, because that reveals the price effect. After appreciation, each unit of domestic currency costs more in foreign money.

3:43An overseas customer therefore needs more of their own currency to buy the same table. Ravensdale receives its unchanged domestic price, while the foreign customer faces a higher cost. Next, compare the table with competing furniture whose prices have stayed unchanged. Ravensdale’s product has become more expensive relative to those alternatives. If customers are sensitive to price, some will choose another supplier. Fewer tables sold at the unchanged domestic price reduce the exporter’s revenue.

4:09Finally, connect that sales effect to the business’s response. Ravensdale could lower its domestic selling price to limit the increase faced by foreign buyers. It would then receive less revenue per table. Managers must judge whether protecting overseas sales is worth accepting a lower amount from each sale. With depreciation, the same domestic selling price costs overseas buyers less in their own currency. Ravensdale’s tables become more price competitive against alternatives whose prices remain unchanged.

4:36This can attract additional foreign orders and increase revenue. The business must still have enough capacity to supply those extra tables. Some businesses experience both effects because they import materials and export finished products. Depreciation can make their exports more attractive while increasing the cost of imported inputs. The overall effect depends partly on the importance of each activity. A furniture exporter using mostly imported timber faces a different situation from Ravensdale.

5:02Businesses selling only to domestic customers can also face changing competition. Appreciation makes imported alternatives cheaper when foreign suppliers keep their prices unchanged. Customers may switch towards those products, which puts pressure on domestic sellers. Following depreciation, dearer imports can make locally produced alternatives more attractive.

Services and combined effects

5:21Services follow the same payment logic as physical products. Pinecliff Lodge provides accommodation for foreign tourists who pay in domestic currency. Their purchases count as exports of services because the customers come from overseas. The accommodation stays in the same place, but the money comes from foreign buyers. After depreciation, tourists need less of their own currency to pay an unchanged room price. A stay at Pinecliff therefore becomes cheaper for them.

5:46This can improve its price competitiveness against accommodation in other countries. More bookings could increase revenue if travellers respond to the lower cost. Appreciation creates the opposite pressure because those rooms become more expensive in the tourists’ currencies. Some travellers may choose another destination, so bookings could fall. Pinecliff’s response might include lowering its domestic room price to protect demand. That decision reduces revenue per booking, so managers must judge the likely effect on total sales.

6:13The outcome also depends on costs and customer priorities. Tourists may value Pinecliff’s location enough to accept a higher price. Meanwhile, any imported food or equipment becomes cheaper after appreciation. A useful explanation separates the effect on customer prices from the effect on the business’s costs.

Business responses and exam explanations

6:30An importer facing depreciation could investigate domestic suppliers to reduce its exposure to foreign currency payments. Suitable alternatives must meet its requirements for price, quality and reliable delivery. After an appreciation, an exporter could cut its domestic selling price and accept lower profit on each sale. Foreign customers then still find its prices attractive. Moving production abroad, closer to overseas customers, is another possible response to a lasting appreciation, although relocation itself creates costs.

6:57Keep the business’s own currency clearly identified when explaining any change. After appreciation, that money buys more of other currencies. Also separate the domestic selling price from the amount a foreign customer pays. An unchanged price in the exporter’s currency can still become more expensive for the overseas buyer. Treat price competitiveness as one influence on sales alongside customer preferences and competing products. Lower prices can encourage purchases, while the actual response depends on the circumstances.

7:26Keep revenue and profit separate when tracing the outcome. Additional sales raise revenue at an unchanged price, but the effect on profit also depends on costs. An exam-style question could ask you to explain how appreciation could affect bookings at Pinecliff Lodge. Explain means set out purposes or reasons, say why and how, supported with relevant evidence. Start with the currency movement, then trace the effect on the customer’s price.

7:51Finish with the likely consequence for bookings, using the case details. Appreciation makes Pinecliff’s unchanged domestic room price more expensive in its foreign guests’ currencies. These tourists must spend more of their own money for the same accommodation. Some may choose cheaper destinations, so bookings could fall. This matters particularly because most of Pinecliff’s guests come from overseas. Fewer bookings at an unchanged room price would reduce the business’s revenue.

8:15For an import question, begin with the overseas supplier’s bill and trace its domestic cost. In either Paper One Short Answer and Data Response or Paper Two Case Study, use the business details given. Imported components direct your explanation towards costs, while foreign tourists point attention towards customer prices. Each link should explain how the next business effect follows. An exchange rate is the price of one currency in terms of another currency.

8:40Keep the buyer, seller and payment currency clear as you trace its effects. Appreciation is a rise in the value of a currency against other currencies. With unchanged original prices, imports become cheaper and exports become dearer abroad. Depreciation is a fall in the value of a currency against other currencies. Under the same conditions, imports become dearer and exports become cheaper abroad. Follow those changes through costs, prices and competitiveness before reaching sales or profit.

9:08The strongest explanation always connects the currency movement to the particular business.