Exchange Rate Equilibrium Demand for a currency  Quantity demanded increases as price of currency decreases Supply of a currency for sale  Quantity supplied increases as price of currency increases 1

Demand Schedule for Pounds

Supply Schedule for Pounds

Equilibrium Exchange Rate

Factors that Influence XRs Relative inflation rates  Increase in U.S. inflation Increased demand for British goods (greater demand for pounds) Decreased demand for U.S. goods in Great Britian (fewer pounds for sale)  Demand and supply curves shift Value of £ increases 5

Rising U.S. Inflation

Factors that Influence XRs Relative interest rates  Increase in U.S. interest rates Less interest in investing in G.B. (decreased demand for pounds) Increased interest by British investors in investing in U.S. (more pounds for sale)  Demand and supply curves shift Value of £ decreases 7

Rising U.S. Interest Rates

Factors that Influence XRs Relative income levels  Increase in U.S. income level Increased demand for British goods (increased demand for pounds) No change in supply of pounds for sale  Demand curve shifts Value of £ increases 9

Rising U.S. Income Level

Factors that Influence XRs Government Controls  Imposing FX barriers  Imposing trade barriers  Intervening in FX markets  Policies affecting inflation, interest rates and income levels 11