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Home > Economics FAQs Blogs > Why does a fall in the prices of exports decrease demand for the pound, particularly in relation to the impact on exchange rates and decreasing terms of trade?

Why does a fall in the prices of exports decrease demand for the pound, particularly in relation to the impact on exchange rates and decreasing terms of trade?

Relevant Topics

This question pertains to topics in Macroeconomics, such as Exchange Rates, International Trade, Balance of Payments

Definitions:

Exports: Goods and services produced in one country and sold to buyers in another country.

Exchange Rates: The price of one currency in terms of another currency.

Terms of Trade: The ratio of an index of a country's export prices to an index of its import prices.

Detailed Explanation:

When the prices of a country's exports fall, foreign buyers need to spend less of their own currency to buy the same quantity of these goods. This reduces the demand for the exporting country's currency, as less of it is needed to buy these goods. As a result, the value of the currency (in this case, the pound) decreases in foreign exchange markets - this is known as a depreciation.

When the value of the pound decreases, it can negatively affect the terms of trade. This is because a depreciation makes imports more expensive (as more pounds are now needed to buy the same quantity of foreign goods), while exports are cheaper. If the price of exports falls, and the price of imports rises, this leads to a worsening of the terms of trade (as the ratio of export prices to import prices decreases).

Recent: 

UK and Brexit: Since the Brexit vote in June 2016, there has been significant uncertainty around the UK's future trading relationships. This has led to a fall in the value of the pound due to lower demand for it, caused in part by concerns that UK exports may be less competitive.

Russia and Oil Prices:
Russia, a significant exporter of oil, experiences changes in the demand for the Russian Ruble based on global oil prices. When oil prices drop, demand for the Ruble tends to decrease because less of the currency is needed to purchase Russian oil. This has led to depreciations in the Ruble.

Summary:

A fall in the prices of exports decreases the demand for the pound as less of the currency is required by foreign buyers to purchase the same quantity of goods. This leads to a depreciation in the value of the pound and a worsening of the terms of trade, as exports become cheaper and imports become more expensive. Real-world examples include the impact of Brexit on the value of the pound and the impact of oil prices on the value of the Russian Ruble. This topic falls under macroeconomics, with specific relevance to exchange rates and international trade.

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