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 Current Exchange Rates Current Exchange Rates Current Exchange Rates Appreciation of the dollar –an increase in the value of the dollar relative to the currency of another nation Appreciation of the dollar –an increase in the value of the dollar relative to the currency of another nation dollar buys more foreign stuff dollar buys more foreign stuff Depreciation of the dollar – a decrease in the value of the dollar relative to another currency 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 dollar buys a smaller amount of foreign currency and thus foreign goods

Floating Exchange Rates Market Exchange Rates determined by Supply and Demand Market Exchange Rates determined by Supply and Demand Items requiring foreign exchange: Items requiring foreign exchange: Services Services Tourism Tourism Business trips Business trips Currency speculators Currency speculators Set-up a manufacturing company Set-up a manufacturing company

An Overview Suppose: Suppose: Canadian Dollars Canadian Dollars Mexican Pesos 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. IF Mexican importers demand Canadian goods they must pay for the goods in Canadian dollars, therefore, an increase in demand for Canadian dollars. Q of C$ Peso Price of C$ D1D1 D2 for C$

Downward Sloping Demand The lower the price of the C$ the more will be demanded 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. 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$ Q of C$ D by Mexico

Upward Sloping Supply Supply of C$ into foreign exchange markets comes from Canadians wishing to buy Mexican goods, services and assets Supply of C$ into foreign exchange markets comes from Canadians wishing to buy Mexican goods, services and assets The higher the C$/peso exchange rate the more pesos will be bought and the more dollars will be supplied. The higher the C$/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$. This is because the price of Mexican goods, services and assets are cheaper in Canadian dollars the higher is the price of the C$. Exchange Rate for Canadian $ Peso Price of C$ Q of C$ S by Canada

Equilibrium Exchange Rates A= Equilibrium exchange rate, A= Equilibrium exchange rate, D C$ = S C$ D C$ = S C$ If exchange rate is below equilibrium, at C$1 =90 pesos then D>S, shown as B-C. If exchange rate is below equilibrium, at C$1 =90 pesos then D>S, shown as B-C. Dealers wanting to earn commission by exchanging money will have to raise the offer price for the C$ to encourage greater supply and reduce the excess demand. This would continue until equilibrium was reached. Dealers wanting to earn commission by exchanging money will have to raise the offer price for the C$ to encourage greater supply and reduce the excess demand. This would continue until equilibrium was reached. In practice the process is very rapid, they adjust to small gaps in rates minute by minute. In practice the process is very rapid, they adjust to small gaps in rates minute by minute. Exchange Rate for Canadian $ Peso Price of C$ Q of C$ S of C$ by Canada D of C$ by Mexico A B C

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. 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. The reverse is true as well. Exchange rates for British Sterling (Pounds)

Currency Terms Appreciate = A rise in the exchange rate is called appreciation. Appreciate = A rise in the exchange rate is called appreciation. Depreciation = A fall in the exchange rate is called depreciation. Depreciation = A fall in the exchange rate is called depreciation. Peso price Of C$ Quantity of C$ D 1 of C$ D 2 of C$ S 1 of C$ S 2 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). A B C

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 Taste and Preferences Increase taste for German cars = increase demand for Euro, therefore euro appreciates Increase taste for German cars = increase demand for Euro, therefore euro appreciates Relative Interest Rates Relative Interest Rates Canada offers high interest rates = increased demand for C$ therefore C$ appreciates Canada offers high interest rates = increased demand for C$ therefore C$ appreciates Income, real Income Income, real Income If GDP increases then increased M, increase supply of their currency, therefore their currency depreciates If GDP increases then increased M, increase supply of their currency, therefore their currency depreciates Prices levels, relative Price Levels Prices levels, relative Price Levels If a country has high inflation, consumers in that country will increase M because M is relatively cheaper, increase supply currency to buy M- currency depreciates If a country has high inflation, consumers in that country will increase M because M is relatively cheaper, increase supply currency to buy M- currency depreciates Speculation – 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 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

China, A Currency Manipulator? China, A Currency Manipulator?