Cambridge IGCSE Economics: Foreign exchange rates (0455) – Revision Notes

These notes condense sections 6.3.1 to 6.3.5 of the Cambridge IGCSE Economics 0455 syllabus for examination in 2026 into recall form. The syllabus is not tiered. For full explanations and longer worked examples, read the study guide, then test yourself with the practice questions. Other links: the Cambridge IGCSE Economics hub, the printable checklist, the free diagnostics and the price elasticity revision. All countries, currencies and figures here are invented.

Key definitions (6.3.1)

Term	Meaning
Foreign exchange rate	How much of one currency buys a unit of another; the price of one currency in the other
Appreciation	A rise in the value of a currency against another
Depreciation	A fall in the value of a currency against another
Floating system	The rate is set by demand and supply in the foreign exchange market
Fixed system	The government or central bank sets a rate and acts to hold it
Foreign exchange reserves	Stocks of foreign currency held by the central bank, used to defend a fixed rate

Setting: Country M uses the mira, Country N uses the nubi, and 1 mira = 1.50 nubi.

Conversions and percentage changes

Step	Rule	Example
Quoted currency into the other	Multiply by the rate	75 miras × 1.50 = 112.5 nubi
Back again	Divide by the rate	270 nubi ÷ 1.50 = 180 miras
Percentage change	(new − old) ÷ old × 100	(1.80 − 1.50) ÷ 1.50 = +20%

The other currency moves by a different percentage. At 1.50 one nubi is worth 1 ÷ 1.50 = 0.667 miras. After the mira falls to 1.20 it is worth 1 ÷ 1.20 = 0.833 miras. The mira fell by (1.20 − 1.50) ÷ 1.50 = −20%. The nubi rose by (0.833 − 0.667) ÷ 0.667 = +25%.

Equilibrium in the foreign exchange market (6.3.2)

Diagram in words: vertical axis, price of the mira in nubi; horizontal axis, quantity of miras traded. The demand curve slopes down. The supply curve slopes up. They cross at the equilibrium rate.

• Demand for miras comes from foreigners buying Country M’s exports, services and assets.
• Supply of miras comes from Country M’s residents buying imports and foreign assets.
• Above equilibrium there is a surplus of miras, so the rate falls. Below equilibrium there is a shortage, so the rate rises.
• Under a fixed rate the same pressures exist, but the authorities buy or sell currency, or alter interest rates, to stop the rate moving.

Method for any shift question:

1. Say which currency’s market you are in.
2. Say which curve moves (demand or supply) and why.
3. Say which way it moves.
4. State the new equilibrium rate: higher (appreciation) or lower (depreciation).

Causes of fluctuations (6.3.3)

Cause	Curve	Result for the mira
More exports bought by foreigners	Demand right	Appreciates
More imports bought by Country M	Supply right	Depreciates
Higher interest rates in Country M	Demand right, supply left	Appreciates
Lower interest rates in Country M	Demand left, supply right	Depreciates
Speculators expect a rise	Demand right	Appreciates
Speculators expect a fall	Supply right	Depreciates
MNC enters, builds a plant	Demand right	Appreciates
MNC departs, sends funds home	Supply right	Depreciates

Reasoning for interest rates: higher rates mean a better return on savings held in miras, so foreign savers buy miras to deposit them, and residents keep more savings at home. Speculation can be self-fulfilling, because selling a currency expected to fall pushes it down.

Consequences (6.3.4)

Change	Export price abroad	Import price at home
Appreciation	Rises	Falls
Depreciation	Falls	Rises

Worked reminder. A table costs 300 miras. At 1.50 a nubi buyer pays 300 × 1.50 = 450 nubi. At 1.20 the price is 300 × 1.20 = 360 nubi, a fall of 20%. A machine costs 600 nubi. At 1.50 it costs 600 ÷ 1.50 = 400 miras. At 1.20 it costs 600 ÷ 1.20 = 500 miras, a rise of 25%.

Spending rule: % change in quantity = PED × % change in price. Spending = price × quantity.

Price change	Elastic demand	Inelastic demand
Price rises	Spending falls	Spending rises
Price falls	Spending rises	Spending falls

Worked reminder. The depreciation cuts the nubi price of tables by 20%. Exports are 1,000 tables, PED = −1.5. Quantity rises 1.5 × 20 = 30%, to 1,300. Spending by nubi buyers goes from 1,000 × 450 = 450,000 to 1,300 × 360 = 468,000 nubi, up 4%. Demand is elastic, so lower prices raise spending.

Evaluation: effects depend on the size of the PED, on how long the change lasts (demand tends to be more elastic over time), and on what other countries do.

Method for a PED spending question:

1. Work out the new price in the buyer’s currency.
2. Find the percentage change in price.
3. Multiply by PED to get the percentage change in quantity.
4. Find the new quantity and multiply by the new price.
5. Compare spending before and after, and link the result to elastic or inelastic demand.

Floating versus fixed (6.3.5)

	Floating	Fixed
For	Self-correcting; no reserves needed; interest rates free for domestic aims	Certainty for traders; supports trade and investment; can restrain inflation
Against	Uncertainty; large swings; speculation; depreciation raises import prices	Reserves can run out; interest rates tied to defending the rate; rate may be set wrongly

Worked reminder. Country M fixes 1 mira = 1.50 nubi. At that rate supply of miras exceeds demand by 8 million per week. The central bank buys 8 million miras, paying 8 × 1.50 = 12 million nubi per week from reserves. With 84 million nubi in reserves it can do this for 84 ÷ 12 = 7 weeks. Then it must raise interest rates, change the fixed rate or find more reserves.

Short judgement: a small economy that trades mostly with one partner may gain from a fixed rate if it has large reserves. A large economy with varied trade may prefer to float.

Must-know distinctions

• Appreciation and depreciation describe a market-driven change in a currency’s value. Under a fixed system, the authorities may alter the fixed rate itself.
• Exports create demand for the home currency. Imports create supply of it.
• Elastic demand: spending moves opposite to price. Inelastic demand: spending moves with price.
• A fall in the rate helps exporters’ prices but raises the cost of imported inputs and goods.

Quick self-test

1. Define a foreign exchange rate.
2. At 1 mira = 1.50 nubi, convert 75 miras into nubi.
3. Convert 270 nubi into miras.
4. The rate moves from 1.50 to 1.80 nubi per mira. State the change and its percentage.
5. Households in Country M want more imports. Which curve shifts, and what happens to the mira?
6. Explain why a higher interest rate in Country M may raise the value of the mira.
7. An import costs 450 nubi. Find its price in miras at 1.50 and at 1.80, and the percentage change.
8. A table costs 300 miras. Find the nubi price at 1.50 and at 1.20, and the percentage change.
9. Imports of a good have PED = −0.6. Its price in miras rises from 400 to 500. Country M first bought 300 units. Find the new quantity and the change in spending.
10. State one advantage and one disadvantage of a fixed exchange rate.

Answers

1. How much of one currency buys one unit of another; the price of one currency in the other.
2. 75 × 1.50 = 112.5 nubi.
3. 270 ÷ 1.50 = 180 miras.
4. An appreciation of the mira: (1.80 − 1.50) ÷ 1.50 × 100 = +20%.
5. Supply of miras shifts right (more miras sold to buy nubi). The mira depreciates.
6. Foreign savers must buy miras to deposit them, so demand rises, and residents keep more savings at home, so supply falls. The rate rises.
7. At 1.50: 450 ÷ 1.50 = 300 miras. At 1.80: 450 ÷ 1.80 = 250 miras. Change = (250 − 300) ÷ 300 × 100 = −16.7%.
8. At 1.50: 450 nubi. At 1.20: 360 nubi. Change = −20%.
9. Price rise = 25%, so quantity falls 0.6 × 25 = 15%, to 255. Spending rises from 300 × 400 = 120,000 to 255 × 500 = 127,500 miras, because demand is inelastic.
10. Advantage: certainty for traders. Disadvantage: needs reserves to defend the rate, and these can run out.

Where marks are usually lost

• Mixing up the direction of conversion: multiply when going into the other currency, divide when coming back.
• Saying “the currency rises” without saying against which currency.
• Shifting the wrong curve: more imports shift supply of the home currency, not demand.
• Writing that a depreciation always improves the trade position, with no mention of PED or time.
• Forgetting that spending is price times quantity, and stopping at the quantity change.
• Using the same percentage for both currencies.
• Describing a fixed rate as “never changing” when the authorities can change it.
• Listing advantages and disadvantages with no judgement about which suits which economy.

Official syllabus

Source: Cambridge IGCSE Economics 0455 syllabus for examination in 2026, version 2, Cambridge University Press & Assessment, section 6.3 Foreign exchange rates (6.3.1 to 6.3.5).