Exchange Rates
What is an exchange rate?
What types of rates exist, and how are they different?
How would you graph supply and demand for a
currency?
Why would exchange rates change?
Current Exchange Rates

Appreciation of the dollar –an increase in
the value of the dollar relative to the
currency of another nation


dollar buys more foreign stuff
Depreciation of the dollar – a decrease in
the value of the dollar relative to another
currency

dollar buys a smaller amount of foreign
currency and thus foreign goods
Floating Exchange Rates


Market Exchange Rates determined by
Supply and Demand
Items requiring foreign exchange:





Services
Tourism
Business trips
Currency speculators
Set-up a manufacturing company
An Overview

Suppose:



Canadian Dollars
Mexican Pesos
IF Mexican importers demand Canadian
goods they must pay for the goods in
Canadian dollars, therefore, an increase in
demand for Canadian dollars.
Peso
Price
of
C$
D1
D2 for C$
Q of C$
Downward Sloping Demand


The lower the price of the
C$ the more will be
demanded
The cheaper the C$ is to
Mexican traders the
cheaper are Canadian
goods, services and
assets. Therefore the
demand curve for the
dollar will slope
downward.

Canadian Dollar Exchange Rate
Peso Price of C$
D by Mexico
Q of C$
Upward Sloping Supply



Supply of C$ into foreign
 Exchange Rate for Canadian $
exchange markets comes from
Canadians wishing to buy
Peso
Mexican goods, services and
Price
S by Canada
assets
of C$
The higher the C$/peso
exchange rate the more pesos
will be bought and the more
dollars will be supplied.
This is because the price of
Mexican goods, services and
assets are cheaper in Canadian
dollars the higher is the price
of the C$.
Q of C$
Equilibrium Exchange Rates




A= Equilibrium exchange rate,
 Exchange Rate for Canadian $
DC$ = S C$
If exchange rate is below
Peso
S of C$
equilibrium, at C$1 =90 pesos Price
by Canada
then D>S, shown as B-C.
of C$
Dealers wanting to earn
commission by exchanging
A
money will have to raise the
100
offer price for the C$ to
B
C
90
encourage greater supply and
reduce the excess demand.
80
This would continue until
equilibrium was reached.
D of C$
by Mexico
In practice the process is very
rapid, they adjust to small
gaps in rates minute by
Q of C$
minute.
Floating Exchange Rates


Suppose there is an
increase in demand
for British goods.
This means that
foreigners need
pounds and the need
for pounds drives up
the exchange rate.
The reverse is true as
well.

Exchange rates for British
Sterling (Pounds)
Currency Terms


Appreciate = A rise in the exchange rate is
called appreciation.
Depreciation = A fall in the exchange rate
is called depreciation.
Peso price
Of C$
S1 of C$
A
S2 of C$
B
C
Quantity of C$
D1 of C$
D2 of C$
A fall in demand of C$ is shown
As a shift in the demand curve
From D1 to D2. An increase in
Supply is shown as a movement
From S1 to S2.
In both cases the exchange rate
Of the C$ will fall, or depreciate
(Conversely, the peso has
Appreciated).
Fixed Exchange Rates


Suppose there is an
increase in demand for
British Sterling= D1 to
D2, thus increasing
exchange rate.
British authorities will
then tap into their
currency reserves and sell
more sterling, thus
increasing supply from S1
to S2, and maintaining
fixed exchange rate.
Determinants of Foreign Exchange
Rates

Taste and Preferences


Relative Interest Rates


If GDP increases then increased M, increase supply of their currency,
therefore their currency depreciates
Prices levels, relative Price Levels


Canada offers high interest rates = increased demand for C$ therefore
C$ appreciates
Income, real Income


Increase taste for German cars = increase demand for Euro, therefore
euro appreciates
If a country has high inflation, consumers in that country will increase M
because M is relatively cheaper, increase supply currency to buy Mcurrency depreciates
Speculation –

If speculators think the currency will do well then buy low and sell high.
If speculators think $ is overvalued and is due for a fall, people holding
$ will rush to sell and the supply of $ will increase - $ depreciates
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