Mechanic of Exchange (Unit 7)

Foreign Exchange (FOREX)

• The buying and selling of currency*example: in order to purchase souvenirs in France, it is first necessary for Americans to sell their dollars and buy Euros

• Any transactions that occurs in the balance of payments necessitates foreign exchange

• Exchange Rate (e) is determined in foreign currency markets

• Exchange rates (e) are a function of supply and demand for currency- an increase in the supply of a currency- a decrease in supply of a currency will increase the exchange  rate of currency- increase in demand for currency will increase the exchange rate of currency- decrease in demand for a currency will decrease the exchange rate of currency

•  Appreciation of currency occurs when exchange rate of that currency increases (e^)

• Depreciation of a currency occurs when the exchange rate of that currency decreases

• Consumer tastes

• Relative income

• Relative price level

•  Speculation

•  Exchange rate is a determinant of both exports and imports

•  Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper, thus reducing exports and increasing imports

• Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing exports and reducing imports

Flexible Rates

• Depends upon supply and demand of that currency vs. other currencies

• Very sensitive to business cycle / provide options for investments

Changes in Exchange Rates

• Exchange rate (e) are a function of the supply and demand for currency.

Appreciation and Depreciation

• Appreciation of a currency occur when the exchange rate of that currency goes up.
• Depreciation of a currency occur when the exchange rate of that currency goes down.

Exchange Rate Determinants

• Consumer tastes
• Relative income
• Relative price level
• Speculation

Export and Import

• The exchange rate is a determinant of both exports and import.