Cambridge International as and a level Economics Ebook

97

---

Cambridge International AS Level Economics
fi rms due to the country’s economic prospects improving. 
Th
ey may also want to buy more of the currency in order 
to open accounts in the country’s banks because of higher 
interest rates. Foreign fi rms may purchase a greater value 
of the currency in order to set up branches in the country, 
perhaps because of a rise in labour productivity in the 
country. Speculation may account for a large proportion of 
the currency purchased. If it is thought that the value of the 
currency will rise, people may buy the currency in the hope 
of making a profi t.
While an increase in demand for the currency will 
push up its price, or at least put upward pressure on its 
value, an increase in its supply will cause a fall in its 
value or put downward pressure on its value. More of 
the currency may be sold to purchase other currencies 
for a variety of reasons, including to purchase more 
imports, to undertake foreign travel, to purchase more 
of the country’s government bonds, to set up fi rms 
abroad and in anticipation of a fall in the value of 
the currency.
Th
e value of a fi xed or managed fl oating exchange 
rate may be changed by the pressure of market forces. For 
example, a government may decide that the currency is 
undervalued because it keeps having to sell the currency 
to maintain its value. In this case, it may decide to revalue 
the currency.
A government may also decide to alter a fi xed exchange 
rate or infl uence an exchange rate within a managed fl oat 
in order to achieve a macroeconomic aim. For instance, a 
government may devalue its currency, possibly below its 
long-run equilibrium level, in order to gain a competitive 
advantage and improve its current account position. 
Alternatively, a government may set a high exchange rate to 
reduce infl ationary pressure.