Foreign Exchange Rates Flexible Exchange Rates Uses demand and supply to determine the value of one nation’s currency compared to another nation’s Equilibrium is the current exchange rate Method used by most nations to determine the value of their currency internationally Lecture 3.2

International Value of a Dollar Appreciated –More foreign currency earned per $1 exchanged –Causes foreign goods to cost less –Increases imports (foreign-produced goods sold in the U.S.) Depreciated –Less foreign currency earned per $1 exchanged –Causes foreign goods to cost more –Increases exports (goods made in U.S. sold in foreign countries)

$1 US in foreign currency Mexican Peso810 British Pound What happened to the value of the US $ compared to the Mexican Peso (appreciate or depreciate)? How do you know? 2.A sombrero in Mexico costs 80 Pesos. How much will it cost In 2000? In 2005? 3.What then happens to the amount an American pays for a product when the dollar appreciates? 4.When the dollar appreciates what will happen to U.S. Imports? Exports? 5.What happened to the value of the US $ compared to the British Pound? How do you know? U.S. imports will? U.S. exports will?

$1 US in foreign currency Mexican Peso810 British Pound What happened to the value of the US $ compared to the Mexican Peso (appreciate or depreciate)? How do you know? Appreciate; more Pesos received per $1 exchanged (8 Pesos per $ in 2000, 10 Pesos per $ in 2005) 2.A sombrero in Mexico costs 80 Pesos. How much will it cost In 2000? $80 / 8 Pesos = $10 paid for the sombrero In 2005? $80 / 10 Pesos = $8 paid for the sombrero 3.What then happens to the amount an American pays for a product when the dollar appreciates? An American pays less since they get more foreign currency per $1 4.When the dollar appreciates what will happen to U.S. Imports? Increase since they cost less for Americans to buy Exports? Decrease; Mexicans pay more pesos to get $1 5.What happened to the value of the US $ compared to the British Pound? How do you know? Depreciate; earn less pounds per $1 exchanged in 2005 than 2000 U.S. imports will? ↓ b/c British goods cost U.S. more U.S. exports will? ↑ b/c British pay less to get each $1 so our goods cost them less

1990 $1 = 150 Yen In the early 90’s the U.S. had a trade surplus with Japan (exported more than we imported) What would happen in this $ market? Japanese would need to buy (demand) $’s to purchase U.S. products Change in Demand for $? Increase Change in Supply of $? None (change in QS in response to price change) Price of $ in Yen (Yen per $) Quantity of $ S Foreign Exchange Market for Dollars D 150Y D1D1 D2D2 200Y Now $1 = 200Yen Dollar appreciates (more F.C. earned per dollar) Exports? Imports? decreaseincrease Trade deficit unfavorable balance of trade

$1 = 200 Yen The U.S. experienced economic growth through the 1990’s, causing a trade deficit (imported more Japanese goods than U.S. exported) What would happen in this $ market? Americans would supply dollars in exchange for Yen (which we use to purchases Japanese products) Change in Supply for $? Increase Change in Demand of $? None (change in QD in response to price change) Price of $ in Yen (Yen per $) Quantity of $ S Foreign Exchange Market for Dollars D 200Y Now $1 = 125 Yen Dollar depreciates (less F.C. earned per dollar) Exports? Imports? increasedecrease Trade surplus favorable balance of trade S1S1 S2S2 125Y

$1 = 150Yen 1. 1 Yen = $? 1Yen  150 = $ Transportation from Tokyo Airport to hotel = 2700Yen Cost in dollars? 2700Yen  150 = $18 $1 = 200Yen 1. 1 Yen = $? 1Yen  200 = $ Transportation from Tokyo Airport to hotel = 2700Yen Cost in dollars? 2700Yen  200 = $ When $ appreciates (strong $), imports will , exports will  causing a trade deficit (unfavorable balance of trade) 2.U.S. exporters benefit from a weak dollar; U.S. importers benefit from a strong dollar. 3.When $ is strong, foreign currency is weak.