Welcome to Econ 414
International Economics
Study Guide
Week Thirteen
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CHAPTER 13
Exchange Rates
and Their Determination:
A Basic Model
2
What is the exchange rate?
•
•
Value of one currency in terms of
another currency
Spot rate = rate for transaction on spot
Is the exchange
rate flow or
stock?
3
Has dollar appreciated or
depreciated?
• Yesterday the spot rate was
€1 = $1.43
• Today the spot rate is
€1 = $1.53
• Dollar has depreciated
4
What is the rate of depreciation of
dollar?
%Δ in Spot Rate =
Beginning Rate - Ending Rate
* 100
Beginning Rate
%Δ = (1.43-1.53)* 100 /1.43
= -7%
Dollar depreciated by 7%
5
Euros per Dollar: What is causing
these fluctuations?
6
Average yearly exchange rate of
euro
•
•
•
•
•
•
•
•
$1.0658 in 1999
$0.9236 in 2000
$0.8956 in 2001
$0.9456 in 2002
$1.1312 in 2003
$1.2439 in 2004
$1.2441 in 2005
$1.2556 in 2006
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Demand and Supply Forces
Affect the Exchange Rate.
•
Foreign Exchange Market
1. Demand Curve
•
Shows the quantity demanded for a
currency by residents of another
country at different exchange rates.
2. Supply Curve
•
Shows the amount of a currency
supplied at a different exchange
rates.
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Consider demand for euro by
Americans
• Why will Americans demand
euro?
• To import European goods and
services
• To buy European bonds/stocks
• To sell the euros later or in a
different location for profits
9
The Demand for euro
$/€
$3
$2
$1
Demand
for Euros
€1
€2
€3
euros
10
Shifts: What if US GDP goes up?
$/€
US income goes up 
Demand D1
D1
Demand for euros
D2
Euros
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International Economics
• Week Ten –Class 2
– Wednesday, November 7
– 11:10-12:00
– Tyndall
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Shifts: What if US Prices go
down?
$/€
Americans buy
fewer European
goods  Demand
goes down D2
D1
Demand for euros
D2
Euros
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Shifts: What if interest rates in
Europe go up?
$/€
US residents would
want to buy more
European bonds
Demand D1
D1
Demand for euros
D2
Euros
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Consider supply of Euro by
Europeans
•
•
•
•
Why will Europeans supply euro?
To importers American goods and services
To buy American bonds/stocks
To sell later or in the different location for
profits
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The Supply of
Euros
$/€
Supply of
Euros
$3
$2
$1
€1
€2
€3
euros
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Shifts: What if European’s
income goes up?
$/€
Europeans will want to
buy more American
goods  Supply of
euro goes up to S1
S2
Supply of Euros
S1
Euros
17
Shifts: What if Europeans expect
euro to appreciate further in the
will supply less now
near future? Europeans
Supply of euro goes down to S
2
$/€
S2
Supply of Euros
S1
Euros
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Equilibrium in the
Foreign Exchange Market
•
Equilibrium Exchange:
– The exchange rate where the quantity
demanded of foreign exchange equals the
quantity supplied.
•
In our examples, the amount of euros U.S.
residents want to buy equals the amount of euros
Europeans want to sell.
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Equilibrium Exchange Rate
$/Euro
Supply
of Euros
2.5
2.0
1.5
Demand
for Euros
100
200 300 400 500
Euros
20
What if Europe’s GDP goes
up?
Euro
$/Euro
Supply of
euro goes up
to S1
depreciates
Supply
of Euros
2.5
S1
2.0
1.5
Demand
for Euros
100
200 300 400 500
Euros
21
What if US prices go up
and EU prices don’t
Demand goes up
Euro
appreciates
because
Americans would
want to buy more
European goods
S1
$/Euro
Supply
of Euros
3.0
Supply
goes down
because
Europeans
buy fewer
American
goods
2.5
2.0
D1
1.5
Demand
for Euros
100
200 300 400 500
Euros
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Are fluctuations in the value of a
currency good or bad for the
economy?
•
No surplus/ shortage
– Good
23
But fluctuations in the value of a currency
discourages international trade or investment.
•
•
•
•
•
I order a US car today for $30,000
Delivery and payment in 6 months
In 6 months, what if $ appreciates against euro?
I have to spend more euros than expected.
Uncertainty discourages international trade
– Bias toward trade within a nation
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But wait; there is a solution
• I can buy dollars in a forward market.
– Sign a contract today to buy $30,000 in six
months for €0.8 per dollar.
• There is a fee involved
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Fluctuating exchange rates have
led to an industry of forecasters.
•
Need reasonably accurate
forecasts for country’s
– GDP
– Inflation
– Interest rate
•
The supply/demand model is good
for general comments about
exchange over the medium to long
run.
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Asst 7: Due before 10:00 PM on
Saturday November 24
• Question 9, Page 316
• This is an individual assignment.
• Make sure to draw a separate graph for each
case.
• This Assignment has 20 points.
• Hey I know it is Thanksgiving.
– That is why I gave one extra day this time.
– Do it before thanksgiving.
– It is really short.
• Happy Thanksgiving
– Save some for me!!!!
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