Pearson Edexcel International GCSE Economics: Exchange rates: rises and falls (4EC1)

This guide covers section 2.2.3 (Exchange rates) of the Pearson Edexcel International GCSE Economics (4EC1) specification, Issue 3, February 2026. It sits in Paper 2, Macroeconomics and the Global Economy. The specification has a single tier of entry, so everything here is for every candidate. All figures are invented and the countries and currencies are made up. For condensed recall use the revision notes, then test yourself with the practice questions. The Edexcel IGCSE Economics hub and the printable checklist show where this fits. To find your weak spots first, try a free 10-minute diagnostic.

What 2.2.3 asks you to know

Ref	What you must be able to do
a)	Define an exchange rate
b)	Explain how interest rates, currency speculators, and imports and exports affect the supply of and demand for a currency; use supply and demand diagrams to show how the rate is determined
c)	Define appreciation and revaluation; explain the impact of appreciation on import and export prices, on demand for imports and exports, and on the current account of the balance of payments
d)	Define depreciation and devaluation; explain the same three impacts of depreciation

a) What an exchange rate is

An exchange rate states how much of one currency is needed to buy one unit of another currency, so it is a price measured in foreign money.

Country A uses the AC (A-coin). Country B uses the BC (B-coin). Suppose 1 AC = 2.50 BC. Both of these statements say the same thing:

• 1 AC buys 2.50 BC.
• 1 BC buys 1 ÷ 2.50 = 0.40 AC.

Worked example 1. A toy costs 30 AC in Country A. A buyer in Country B must pay 30 × 2.50 = 75 BC. A jacket costs 12 BC in Country B. A buyer in Country A pays 12 ÷ 2.50 = 4.80 AC. To change 400 BC into AC, divide by 2.50: 400 ÷ 2.50 = 160 AC.

Rule of thumb: to go from the currency that is “1” in the quote (AC) to the other (BC), multiply. To go back, divide. Check that your answer is sensible: BC amounts should be bigger than AC amounts here, because each AC is worth more than one BC.

b) What decides the exchange rate

In a floating exchange rate system the rate is set by the market: the demand for and supply of the currency. The rate is the price of the currency, so the usual market logic applies.

Demand for AC comes from people who need to buy AC. These are foreign buyers paying for Country A’s exports, foreign tourists visiting Country A, and foreign investors and savers who want to hold assets in Country A.

Supply of AC comes from people who sell AC to get foreign money. These are Country A residents paying for imports, Country A tourists abroad, and savers and firms sending money overseas.

Here is a market for AC, with the price measured in BC per AC and quantities in millions of AC per day (illustrative).

Rate (BC per AC)	Demand for AC	Supply of AC
3.50	40	100
3.00	55	85
2.50	70	70
2.00	85	55
1.50	100	40

The equilibrium rate is 2.50 BC per AC, with 70 million AC traded. At 3.00 supply (85) exceeds demand (55), so there is a surplus of AC and the rate falls. At 2.00 demand exceeds supply, so the rate rises.

Diagram described in words: put the exchange rate (BC per AC) on the vertical axis and the quantity of AC on the horizontal axis. Draw demand (D) as a line falling from left to right and supply (S) as a line rising from left to right. They cross at the equilibrium rate of 2.50 and quantity 70.

Rate
(BC per AC)
 3.50 |    \       /   D falls, S rises
 3.00 |      \   /
 2.50 |        X   equilibrium: 2.50, 70
 2.00 |      /   \
 1.50 |    /       \
     +----------------------- Quantity of AC

Why does demand slope down? At a lower rate, Country A’s goods are cheaper in BC, so foreign buyers want more of them and need more AC. Why does supply slope up? A higher rate makes imports cheaper in AC, so residents buy more imports and sell more AC.

Factors that shift the curves

Imports and exports. If foreign demand for Country A’s exports rises, foreign buyers need more AC: demand shifts right and the rate rises. If Country A’s households buy more imports, they sell more AC to pay for them: supply shifts right and the rate falls.

Interest rates. If Country A raises its interest rate, savings in Country A earn more. Foreign savers move money into Country A and must buy AC first, so demand for AC rises. Residents also have less reason to send savings abroad, so supply of AC may fall. The rate rises.

Currency speculators. Speculators buy and sell currencies hoping to profit from changes in the rate. If they expect the AC to rise, they buy it now, which raises demand and can push the rate up. If they expect a fall, they sell it, raising supply and pushing the rate down. Expectations can therefore partly come true because of what speculators do.

Worked example 2 (interest rates). Using the table above, demand is D = 145 − 30r and supply is S = 30r − 5, where r is the rate. A rise in Country A’s interest rate shifts demand right by 30 at every rate: D’ = 175 − 30r. Set D’ = S: 175 − 30r = 30r − 5, so 180 = 60r and r = 3.00. Quantity is 30 × 3.00 − 5 = 85. The rate has risen from 2.50 to 3.00 BC per AC, and 85 million AC are traded.

Worked example 3 (imports). Now suppose a boom in spending on imports shifts supply right by 30: S’ = 30r + 25. Set D = S’: 145 − 30r = 30r + 25, so 120 = 60r and r = 2.00. Quantity is 145 − 60 = 85. The rate has fallen from 2.50 to 2.00.

c) Appreciation and revaluation

Appreciation happens when market forces in a floating system push a currency’s value up against another currency. Revaluation is a rise in the value of a currency that the government or central bank chooses, when it sets the rate (a fixed system). The effect on trade is the same. Only the cause differs.

Worked example 4. Suppose the AC appreciates from 2.50 to 3.00 BC.

• Percentage change: (3.00 − 2.50) ÷ 2.50 × 100 = 20% appreciation.
• Country A’s toy still costs 30 AC at home. In Country B it now costs 30 × 3.00 = 90 BC, up from 75 BC. That is a 20% rise: export prices rise in foreign currency.
• Country B’s jacket still costs 12 BC. In Country A it costs 12 ÷ 3.00 = 4.00 AC, down from 4.80 AC. That is a fall of 0.80 ÷ 4.80 = 16.7%: import prices fall in home currency.

Notice the 20% and 16.7% are not equal. A percentage change in the rate and the percentage change in the inverse price are not the same size.

Effect on demand. Dearer exports mean foreign buyers cut back, so the quantity of exports demanded falls. Cheaper imports mean residents buy more, so the quantity of imports rises. The size of these changes depends on price elasticity of demand (see the elasticity guide).

Effect on the current account. Look at the balance on goods and services, which is exports minus imports within the current account. Appreciation usually reduces export earnings and raises spending on imports if demand for imports is elastic (more units bought at a lower price), so the current account tends to move towards deficit, or the surplus shrinks. If demand for exports is very inelastic, export earnings could even rise because the price rise outweighs the small fall in quantity.

d) Depreciation and devaluation

Depreciation is a fall in the value of a currency, caused by market forces in a floating system. Devaluation is a fall that the government or central bank chooses when it lowers a fixed rate.

Worked example 5. Suppose the AC depreciates from 2.50 to 2.00 BC.

• Percentage change: (2.00 − 2.50) ÷ 2.50 × 100 = −20%.
• The toy now costs 30 × 2.00 = 60 BC in Country B, down from 75 BC: export prices fall by 20%.
• The jacket costs 12 ÷ 2.00 = 6.00 AC in Country A, up from 4.80 AC: import prices rise by 1.20 ÷ 4.80 = 25%.

Effect on demand. Cheaper exports raise the quantity of exports demanded abroad. Dearer imports cut the quantity of imports bought at home, and some households switch to home-produced goods.

Worked example 6 (current account). Country A, before the depreciation (rate 2.50):

• Exports: 5,000 units at 30 AC = 150,000 AC.
• Imports: 40,000 units at 4.80 AC = 192,000 AC.
• Balance: 150,000 − 192,000 = −42,000 AC (deficit).

After depreciation to 2.00, suppose price elasticity of demand for exports is 1.5 and for imports is 0.6.

• Export price in BC falls 20%, so quantity rises 1.5 × 20% = 30%: 6,500 units × 30 AC = 195,000 AC.
• Import price in AC rises 25%, so quantity falls 0.6 × 25% = 15%: 34,000 units × 6.00 AC = 204,000 AC.
• New balance: 195,000 − 204,000 = −9,000 AC. The deficit has shrunk by 33,000 AC.

Now change the elasticities. Suppose export elasticity is 0.5 and import elasticity is 0.3.

• Exports: 5,500 units × 30 AC = 165,000 AC.
• Imports: 37,000 units × 6.00 AC = 222,000 AC.
• Balance: −57,000 AC. The deficit has got worse by 15,000 AC.

Depreciation improves the current account only if the extra export earnings (and fall in import quantities) outweigh the higher price paid for each import. With inelastic demand it may not.

Evaluating exchange rate changes

Good evaluation compares the winners with the losers and says which conditions the result rests on.

• Exporters gain from depreciation (cheaper abroad, more sales) and lose from appreciation.
• Importers and consumers of imports gain from appreciation (cheaper goods) and lose from depreciation.
• Firms using imported materials face higher costs after depreciation, which may cancel the gain in competitiveness.
• Time: buyers may not change habits straight away, so the current account may take a while to respond.
• Elasticity: the larger the elasticities, the more likely a depreciation helps the current account.

A short chain for an extended answer: depreciation, export prices fall abroad, demand for exports rises, export earnings rise (if elastic), import prices rise, import quantity falls, current account balance improves. Finish with a judgement that names what it depends on, such as elasticity and time.

Common errors

• Writing “the rate rises” without saying which currency is being priced.
• Multiplying when you should divide in a conversion.
• Saying a weak currency always improves the current account.
• Mixing up appreciation (market) with revaluation (government choice).
• Forgetting that a rise in home interest rates raises demand for the home currency.
• Applying a percentage change to the wrong base: divide by the original value.

Official syllabus

Pearson Edexcel International GCSE in Economics (4EC1) specification, Issue 3, February 2026, published by Pearson Education Limited, section 2.2.3.