2. Section 3: International Economics 3.2 Exchange Rates

3. Exchange rates – diagram labelling and terminology Q 0 S D Price of rupees in US$ Market for rupees US$ per rupee Equilibrium of demand and supply gives us the exchange rate. Equilibrium ↑, appreciation Equilibrium ↓, depreciation e q

4. Exchange rates – Demand for exports Q 0 S D Market for rupees e q D1D1 e1e1 q1q1 Buying exports = buying the currency Buying more exports = increase in demand = appreciation Buying fewer exports = decrease in demand = depreciation D2D2 e2e2 q2q2 US$ per rupee

5. Exchange rates – Demand for imports Q 0 S D Price of rupees in US$ Market for rupees e q e1e1 q1q1 Buying imports = selling the currency Buying more imports = increase in supply = depreciation Buying fewer imports = decrease in supply = depreciation e2e2 q2q2 S1S1 S2S2

6. Exchange rates – Relative interest rates Q 0 S D Market for rupees e q e1e1 q1q1 The higher the interest rate, the more people will want to invest in the country. Increase in local interest rate = increase in demand = appreciation Increase in o/s interest rates = increase in supply = depreciation e2e2 q2q2 S1S1 D1D1 US$ per rupee

7. Exchange rates – Relative inflation rates Q 0 S D Price of rupees in US$ Market for rupees e q e1e1 q1q1 The higher the inflation rate, the less attractive your exports are. Increase in local inflation rate = decrease in demand = depreciation Increase in local inflation rate = increase in supply = depreciation e2e2 q2q2 S1S1 D1D1

8. Exchange rates – Foreign investment in firms Q 0 S D Market for rupees e q e1e1 q1q1 Foreign investment can be in the form of foreign direct investment or portfolio investment Increase in foreign investment in local firms = increase in demand = appreciation Decrease in foreign investment in local firms = increase in supply = depreciation e2e2 q2q2 S1S1 D1D1 US$ per rupee

9. Exchange rates – Speculation Q 0 S D Price of rupees in US$ Market for rupees e q e1e1 q1q1 Investors buying and selling currencies to make profit People think currency will appreciate = increase in demand = appreciation People think currency will depreciate = increase in supply = depreciation e2e2 q2q2 S1S1 D1D1