Foreign Exchange

• Foreign Exchange- the buying and 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 currencies markets
• Ex. The current exchange rate is approximately 77 Japanese Yen to 1 U.S. dollar
• The exchange rate is a price of a currency
• Do not try to calculate the exact exchange rate

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's graphs in the same direction (right or left) and you will have the correct answer
• If D on one graph increases, S on the other will also increase
• If D moves to the left, S will move to the left on the other graph

Changes in Exchange Rates

• Exchange rates are a function of the supply and demand currency
• An increase in the supply of a currency will make it cheaper to buy one unit of that currency
• A decrease in supply of a currency will make it more expensive  to buy one unit of that currency
• An increase in demand for currency will make it more expensive to buy one unit of that currency
• A decrease in demand for a currency will make it cheaper to buy one unit of that currency.

Appreciation

• Appreciation of a currency occurs when the exchange rate of that currency increases
• Hypothetical: 100 Yen used to buy one dollar. Now 200 Yen buy one U.S. dollar
• The dollar is stronger because one buys more Yen than it used to.

Depreciation

• Depreciation of a currency occurs when the exchange rate of that currency decreases
• 100 Yen used to buy one dollar. Now 50 yen buys one dollar.
• The dollar is weaker because it takes fewer Yen to buy one dollar.

Dollar Appreciation

• Each dollar gets you more of the other currency
• U.S. exports gets more expensive for foreigners
• U.S. imports gets cheaper for the U.S.
• Exports decrease
• Imports increase
• Money is leaving the U.S.
• Xn decreases
• GDP decreases
• Increase in demand for the dollar
• Decrease in supply of the dollar

Dollar Depreciation

• Each dollar gets you less of the other currency
• Less of the foreign currency is needed to buy each dollar
• Exports increase
• Imports decrease
• Money is entering the U.S.
• Xn increases
• GDP increases
• Demand for the dollar decreases
• Supply of the dollar increases

Supply of the Dollar

• Sources:
1. US citizens
2. Banks
3. Industries wanting to purchase our goods, investments, and assets

Making transferred payments to foreigners --> (Supply)

Foreigners are making transfer payments to us --> (Demand)

Purchasing Power Parity- when the currency rates are set by international markets; changes will be made based on the actual purchasing power of the currencies

Why do we exchange currencies?

1. To sell exports and buy imports
2. To invest in another country's stocks and bonds
3. Build stores or factories in another country
4. To speculate on currency values
5. To hold currencies in bank accounts for future exports, imports, and business loans
6. To control excessive imbalances