How Exchange Rates Affect Exports and Imports
Learn how a stronger or weaker pound affects UK export prices and import costs, with a worked example and the key A Level Business exam mistake to avoid.
When the pound appreciates, UK exports usually become more expensive for overseas customers, while imports usually become cheaper for UK businesses. When the pound depreciates, the opposite usually happens. These effects assume businesses keep their prices unchanged in their own currency and pass the exchange rate change on to customers.
Why prices change
An exchange rate tells you how much one currency is worth in another. Appreciation means a currency gains value; depreciation means it loses value. If the pound appreciates, a customer paying in euros needs more euros to buy a UK product priced in pounds. At the same time, a UK business needs fewer pounds to pay for goods priced in euros.
Worked example
Suppose the exchange rate changes from £1=EUR 1.20\pounds 1 = \text{EUR }1.20£1=EUR 1.20 to £1=EUR 1.40\pounds 1 = \text{EUR }1.40£1=EUR 1.40. The pound has appreciated because each pound now buys more euros.
A UK export priced at £100\pounds 100£100 rises from EUR 120\text{EUR }120EUR 120 to EUR 140\text{EUR }140EUR 140 for a euro-paying customer, if its pound price stays fixed. An imported component priced at EUR 120\text{EUR }120EUR 120 falls in cost from £100\pounds 100£100 to approximately £85.71\pounds 85.71£85.71 for the UK business, if its euro price stays fixed.
Cheaper imports can reduce a business's costs, but dearer exports may reduce overseas sales. A depreciation can make exports cheaper abroad while raising the cost of imported materials.
The size of the effect on sales depends on price elasticity of demand: how strongly customers change the quantity they buy when price changes. If overseas buyers can easily switch to competing products, a higher euro price may cause a larger fall in export sales. If the product is distinctive, demand may change less. Exchange rates can also affect a business's competitiveness relative to overseas rivals.
Exam mistake to avoid: Do not say an exchange rate change automatically changes every selling price. A business might adjust its prices or accept a lower profit margin. Explain the likely direction of the effect, then consider how the business responds.
