Unit 7 Foreign Exchange

May 3,2016 

Foreign exchange (FOREX) 

• the buying and selling of currency 
• Any transaction that occurs in the balance of payments necessitates foreign exchange 
• The exchange rate (e) is determined in the foreign currency markets - [ex. the current exchange rate is approximately 8 yuan to 1 dollar] 

Changes is exchange rates 

• exchange rates (e) are a function of the supply and demand for currency 

• an increase in the supply of currency will decrease the exchange rate of a currency 
• A decrease in supply of a currency will increase the exchange rate of a currency 
• An increase in demand for a currency will increase the exchange rate of a currency 
• A decrease in demand for a currency will decrease the exchange rate of a currency 

Appreciation and depreciation 

• appreciation of a currency occurs when the exchange rate of that currency increases (e⬆️) 
• Depreciation of a currency occurs when the exchange rate of that currency decreases (e⬇️) 

Exchange rate determinants 

1. Consumer tastes 
2. Relative income 
3. Relative price level 
4. Speculation 

Exports and imports 

• the 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 this 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