1. Graphing Currency Movements
Exchange Rates
Graphing Currency Movements

2. 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”

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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