# eli5: How do currency rate changes happen?

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If £1 is £1 how does the value of it change? It’s still 100p so shouldn’t there be a set conversion rate? I don’t understand how the VALUE of it changes.

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The value of a currency can change due to supply and demand dynamics in the foreign exchange market. When demand for a currency increases, its value rises relative to other currencies, and vice versa. Factors such as interest rates, economic indicators, political stability, and market sentiment all influence currency exchange rates. So, while £1 is always £1 in nominal terms, its purchasing power relative to other currencies can fluctuate based on these factors.

The value of it is measured against what it can purchase; it’s purchasing power. This changes because of inflation (or less typically, deflation).

Another way to measure it is against another currency (typically the US dollar). This rate is constantly being reassessed (and typically changing) by the law of supply and demand. The £ is constantly being bought and sold on the currency markets. If there is high demand for it, its exchange rate will rise. Low demand means its exchange rate will fall.

1 pound buys 400gm of butter today. Tomorrow, 1 pound buys 300gm of butter. The value has changed.

When we say something costs some amount of money. This is an exchange rate between money and that thing. Prices change all the time so the value of the currency changes all the time. This is what most people encounter daily.

Some companies and people, import and export goods to other countries. So they are concerned with how much a certain currency costs in terms of another currency. This is the currency exchange rate (basically how much of one in EXCHANGE for another). This exchange rate changes depending on whether that particular currency is in demand or not. This would be a bit beyond ELI5.

There isn’t exactly a true y USD = x GBP = z Yen. Often you have to look at how each interacts with its own economy. If 1 USD = 1 Generic-product in the US, while 1 GBP = 2 Generic-product in the UK, it would be silly to make 1 USD an equivilent exchange to 1 GBP, as in this super simplified case the latter has twice the buying power.

So in the actually very complicated case, you’re looking still at buying power, but in a more economy-wide level. Fluctuations happen between currency exchange rates because the “value” of each currency isn’t completely stable over time. 1 USD gets you less than 1 GBP, but significantly more than 1 Yen. How much more/less depends on the time and state of the countries using these currencies, and the exchange rate reflects that.