Download Graphing Exchange Rates

Exchange Rates
Graphing Currency Movements
Exchange Rates
• Nominal exchange rate- rate at which a person can
exchange currency
– Example: Dollars for Euros => Give $1.35 dollars to receive 1.0 Euro
• Real exchange rate- rate at which a person can trade
goods & services between countries
– Example: Rice in Japan vs. Rice in USA
– Purchasing Power Parity = “law of one price”
Changing Exchange Rates
• Appreciation = increase in value of currency
– Dollar appreciates => Imports cheaper & Exports more expensive
– Leads to larger Trade Deficit (NX↓ ) & AD shifts left
• Depreciation = decrease in value of currency
– Dollar depreciates => Imports more expensive & Exports cheaper
– Leads to smaller Trade Deficit (NX↑ ) & AD shifts right
Flexible Exchange Rates
• FIXED exchange rates
– a set, agreed upon relationship between currencies or a currency value
expressed in a precious asset (gold)
– Example: Chinese Yuan
• FLOATING exchange rates
– free market rates- supply & demand determine exchange rates
– Example: almost all major currencies
Graphing Exchange Rates
Market for Dollars
S1
Euro Price
of a dollar
1) Currency are priced in other currencies
2) All FX trades are executed in the market for
foreign exchange
Hint: pretend a “house of foreign exchange” is located on a
remote island where all currency is exchanged….
--------------
.75 Euro --------------
Q1
D1
House of
Foreign
Exchange
Qty of Dollars
This label determines the market
you are graphing:
Market for US dollars
Priced in Euros
Euro Depreciates!
1.40 => 1.08 Dollars to Euro
Determinants of Exchange Rates
1. Changes in Consumer Tastes
2. Relative Income Changes
3. Relative Price Level Changes
“Purchasing Power Parity Theory”
4. Relative Real Interest Rates
5. Speculation & Investment
U.S. Income
Rises
Demand
Imports
Products should cost
the same in real terms
in each country
Demand
Foreign
Currency
Event: US invents new breakthroughs in technology products
Market for Dollars
Market for Euros
S1
Euro Price
of a dollar
Q1
1.35 Dollars --------------
D1
Qty of Dollars
--------------
--------------
.75 Euro --------------
S1
Dollar Price
of a Euro
Q1
D1
Qty of Euros
The Market for Foreign Exchange
P
Market for Dollars
S
S1
3
Dollar
depreciates
Supply of US
dollars increases
2
Dollar depreciates
Against Euro
1
D
Quantity of dollars
Q
Worksheet #1