Currency Appreciation vs Exchange Rate
Currency Appreciation and Exchange Rate are two International Trade & Finance concepts in AP Economics that students often mix up. Currency appreciation is an increase in the value of a currency relative to another in the foreign exchange market. An exchange rate is the price of one country's currency expressed in terms of another currency. Here is how they compare side by side.
It results from rising demand for the currency or falling supply, often driven by higher interest rates or stronger growth. An appreciating currency makes exports more expensive and imports cheaper, reducing net exports. It is the opposite of depreciation.
It is set in the foreign exchange market by the supply of and demand for currencies. A higher exchange rate (appreciation) makes imports cheaper and exports more expensive. Exchange rates affect net exports and aggregate demand.
Currency Appreciation vs Exchange Rate: A Movement and the Level It Moves
| Currency Appreciation | Exchange Rate | |
|---|---|---|
| Kind of quantity | A change between two dates, normally quoted as a percentage | A level, complete and readable at a single instant |
| How many currencies it names | One, the currency that gained value | Two, and the order they appear decides what a rising number means |
| When pesos per dollar goes from 20 to 25 | The dollar appreciated by 25 percent | The quoted level rose by 5 pesos, while the peso lost 20 percent of its dollar value |
| On the foreign exchange diagram | The equilibrium reading on the vertical axis moving up | The vertical axis itself, priced in the other currency |
| What produces it | Demand for that currency shifting right or its supply shifting left | The whole market equilibrium, not any single force |
| Wording that costs marks | None, naming a currency removes the ambiguity | The exchange rate rose, which does not tell a reader which currency gained |
The two percentages describing one move are never the same size
Work one move from both sides and the percentages disagree, which catches people out the first time. The rate goes from 20 pesos per dollar to 25 pesos per dollar. For the dollar that is a rise of 5 on a base of 20, an appreciation of 25 percent. For the peso, its dollar price falls from one twentieth, which is 0.05 dollars, to one twenty fifth, which is 0.04 dollars, a depreciation of 20 percent. One event, 25 percent read one way and 20 percent read the other, because each side divides by its own starting value. A goods example shows the size of it. A shirt priced at 500 pesos costs an American buyer 25 dollars before the move and 20 dollars after, a fifth off. A machine priced at 30 dollars costs a Mexican buyer 600 pesos before and 750 pesos after, a quarter more. Both price changes come from the same single move in the rate. When a question hands you one percentage and asks for the other currency, invert the two rates and recompute, because reversing the sign on the percentage you were given produces the wrong answer every time. The mirror image of this move is set out at /glossary/currency-depreciation.
On the exam diagram the appreciation is a reading on the axis, not the shift you drew
The foreign exchange diagram in this course is drawn for one named currency at a time. Put the quantity of dollars on the horizontal axis and the price of a dollar, measured in pesos, on the vertical axis. The exchange rate is that vertical axis and the equilibrium sitting on it. An appreciation of the dollar is that equilibrium reading moving up, and you produce it by shifting demand for dollars right or the supply of dollars left. Two errors show up repeatedly. The first is answering in the wrong market. If the prompt says foreign investors are buying American bonds, demand for dollars rises in the dollar market, and the same story appears in the peso market as an increase in the supply of pesos, so a student who draws one market and describes the other reports the direction backwards. The second is labelling the vertical axis with the same currency that is on the horizontal axis. The axis price has to be in the other currency. Write the label out in full as pesos per dollar before you shift anything and the direction of the appreciation reads straight off the picture.
Frequently asked questions
Is appreciation the same as the exchange rate going up?
Appreciation means one named currency gained value against another, while an exchange rate going up only means the quoted number rose, and that number can be written either way round. A rate quoted as pesos per dollar rising from 20 to 25 is a dollar appreciation. The same event quoted as dollars per peso is a fall, from 0.05 to 0.04. Name the currency that gained instead of saying the rate rose, because the second phrasing leaves a reader unable to tell which currency you mean.
If the rate moves from 20 to 25 pesos per dollar, how much did the peso lose?
The peso lost 20 percent of its dollar value even though the dollar gained 25 percent. Before the move a peso bought one twentieth of a dollar, which is 0.05 dollars, and afterwards it bought one twenty fifth, which is 0.04 dollars, a fall of 0.01 on a base of 0.05. The two percentages differ because each currency divides by its own starting value. Invert the quoted rates and compute the second figure from scratch whenever a question asks about the other side of the move.
Does a high exchange rate number mean a currency is strong?
A high exchange rate number says nothing about strength on its own, because the size of the number depends entirely on which currency sits on top of the quote. A currency worth very little per unit shows a large number when the rate is written as units per dollar and a small number when it is written the other way round. Strength is about the direction of movement over time and about what the currency buys, not about the size of the printed figure. Compare a currency with its own earlier readings, quoted the same way round.
Live Exchange Rates graph. Drag the curves, or open the full version.
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