1. Introduction to Economics: Social Issues and Economic Thinking Wendy A. Stock PowerPoint Prepared by Z. Pan CHAPTER 13 FOREIGN EXCHANGE AND THE INTERNATIONAL TRADE OF MONEY Copyright © 2013 John Wiley & Sons, Inc. / Photo Credit: ©MARIA TOUTOUDAKI/iStockphoto

2.  Understand how foreign exchange markets operate  Demonstrate how foreign exchange rates are determined  Describe how foreign exchange rates influence international trade Copyright © 2013 John Wiley & Sons, Inc. 2 AFTER STUDYING THIS CHAPTER, YOU SHOULD BE ABLE TO:

3.  The Exchange Rate is the rate at which one currency can be exchanged for another. It is usually stated in terms of how many units of one currency can be bought with one unit of a different currency. e.g. 1 USD = 0.71 EUR Copyright © 2013 John Wiley & Sons, Inc. 3 FOREIGN EXCHANGE MARKETS

4.  The demand for Euros comes from people who need to exchange U.S. dollars for Euros. e.g. U.S. importers of French wine or other products, U.S. tourists, and U.S. investors who want to invest in French companies.  The supply of Euros comes from people and firms who want to buy U.S. dollars. e.g. French citizens or businesses want to purchase U.S. goods and services or travel to the U.S. Copyright © 2013 John Wiley & Sons, Inc. 4 THE DEMAND AND SUPPLY OF FOREIGN CURRENCIES

5. Copyright © 2013 John Wiley & Sons, Inc. 5 FOREIGN EXCHANGE MARKET

6. Copyright © 2013 John Wiley & Sons, Inc. 6 FOREIGN EXCHANGE MARKET

7. Copyright © 2013 John Wiley & Sons, Inc. 7 CHANGES IN DEMAND AND SUPPLY

8.  When the price of currency A rises relative to currency B, currency A has appreciated.  When the price of currency A falls relative to currency B, currency A has depreciated. Copyright © 2013 John Wiley & Sons, Inc. 8 APPRECIATION VS. DEPRECIATION

9. Copyright © 2013 John Wiley & Sons, Inc. 9 CHANGES IN DEMAND AND SUPPLY

10.  Tastes and Preferences: Changes in tastes and preferences for a certain country’s goods and services can change the demand for that country’s currency.  Income: Assuming that foreign goods and services are normal (rather than inferior) goods, increases in people ’s incomes in one country can increase their demand for foreign goods and services. Copyright © 2013 John Wiley & Sons, Inc. 10 FACTORS SHIFTING SUPPLY AND DEMAND

11.  Expectations: People’s expectations about the future influence their demand for goods and services today.  Interest Rates: If interest rate in Europe is higher than United States, lenders and investors will increase lending and investing in Europe, increasing demand for Euros.  Risk: If lending in Europe becomes more risky, lenders will decrease lending and investing there, decreasing demand for Euros. Copyright © 2013 John Wiley & Sons, Inc. 11 FACTORS SHIFTING SUPPLY AND DEMAND

12.  Exports: Goods or services produced domestically but sold abroad.  Imports: Goods or services produced abroad but sold domestically.  Trade surplus: When a country ’s level of exports exceeds its level of imports.  Trade deficit: When a country ’s level of imports exceeds its level of exports. Copyright © 2013 John Wiley & Sons, Inc. 12 INTERNATIONAL TRADE

13.  A ppreciation of U.S. dollar relative to Euro will lead to a reduction in U.S. exports to Europe.  Appreciation of U.S. dollar against Euro simultaneously involves a depreciation of Euro against U.S. dollar.  Depreciation of Euro will lead to an increase in European exports to the U.S. Ceteris paribus Copyright © 2013 John Wiley & Sons, Inc. 13 VALUE OF FOREIGN CURRENCIES & INTERNATIONAL TRADE

14.  De preciation of U.S. dollar against Euro will lead to an increase in U.S. exports to Europe and a decrease in U.S. imports from Europe.  Depreciation of U.S. dollar against Euro simultaneously involves an appreciation of Euro against U.S. dollar.  Appreciation of Euro will lead to a decrease in European exports to the U.S. Copyright © 2013 John Wiley & Sons, Inc. 14 VALUE OF FOREIGN CURRENCIES & INTERNATIONAL TRADE

15.  In Flexible or Floating Exchange Rate System, exchange rates are determined by demand and supply in the foreign exchange markets.  In Fixed or Pegged Exchange Rate System, exchange rates are kept constant through government action in foreign exchange markets. Copyright © 2013 John Wiley & Sons, Inc. 15 FIXED AND FLEXIBLE EXCHANGE RATES

16. Copyright © 2013 John Wiley & Sons, Inc. 16 FIXED EXCHANGE RATE SYSTEM

17. QUESTIONS/DISCUSSIONS Copyright © 2013 John Wiley & Sons, Inc. 17 1.What are the costs and benefits having a fixed exchange rate system? 2.What are some factors that would cause an increase in the demand for Mexican Pesos relative to U.S. dollars?

18. Copyright © 2013 John Wiley & Sons, Inc. 18 KEY CONCEPTS Exchange rate Appreciated Depreciated Exports Imports Trade surplus Trade deficit Flexible or floating exchange rate system Fixed or pegged exchange rate system