Foreign Exchange

Foreign Exchange (FOREX) - The buying/selling of currency

• Ex. In order to purchase souvenirs in France, it is first necessary for Americans to sell (supply) their dollars and buy (demand) Euros

• The exchange rate (e) is determined in the foreign currency markets
• Ex. The current exchange rate is approximately 77 Japanese Yen to 1 US dollar

• Exchange rate is price of a currency

4 Important Tips

• Always change the D line on one currency graph, the S line on the other currency's graph

• Move the lines of the two currency graphs in the same direction (right or left) and you have correct answer)

• If D on one graph increases, S on the other will also increase

• If D moves left, S moves left on other graph

Changes in Exchange Rates

• Exchange rates (e) are a function of the supply and demand for currency
• An increase in supply of currency makes it cheaper to buy one unit of it, vice versa for a decrease in supply
• An increase in demand of currency will make buying one unit more expensive, vice versa for decrease in demand

• Appreciation - Occurs when the exchange rate of that currency increases (e increases)

• Depreciation - Occurs when exchange rate of that currency decreases (e decreases)

Determinants of Exchange Rate

• Consumer Tastes
• Ex. A preference for Japanese goods creates an increase in demand of Yen and an increase in the supply of the dollar

• Relative Economy
• Imports tend to be normal goods
• Ex. if Mexico's economy is becoming stronger and the U.S. Economy is in recession, Mexicans will buy more of everything including American goods
• Increases demand for dollar, causing dollar to appreciate and the peso to depreciate

• Relative Price Level
• If PL is higher in Canada than in US, American g

• Speculation
• Other currency will appreciate as demand for it increases
• Supply of dollar will increase causing it to depreciate