Graphing Currency Movements 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

This label determines the market Graphing Exchange Rates Currency are priced in other currencies 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…. Market for Dollars S1 Euro Price of a dollar D1 House of Foreign Exchange .75 Euro -------------- -------------- Q1 Qty of Dollars This label determines the market you are graphing: Market for US dollars Priced in Euros

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 Products should cost the same in real terms in each country U.S. Income Rises Demand Imports Demand Foreign Currency

Event: US invents new breakthroughs in technology products Dollar Price of a Euro Qty of Euros D 1 S -------------- 1.35 Dollars Q Market for Euros Euro Price of a dollar Qty of Dollars .75 Euro Market for Dollars

Supply of US dollars increases The Market for Foreign Exchange P Market for Dollars S S1 3 2 1 Euro price of 1 $Dollar Dollar depreciates Supply of US dollars increases Dollar depreciates Against Euro D Q Quantity of dollars