Hamza and Ashvin

Exchange Rates

● An exchange rate takes the price of one country’s currency and expresses it in terms of another country’s currency.

○ Eg: 1 Euro is equivalent to $1.50 in Canadian currency.

● Some exchange rates are always the same (They never change) because the currencies being compared have a fixed exchange rate.

○ This system is used when a country’s currency is always worth exactly the same amount as another country

○ Eg: Two Belize dollars are ALWAYS one U.S. dollar.

○ Often used by smaller countries, who wish to have more control over their economy.

● Other countries have exchange rates which keep changing since they have floating exchange rates.

○ The value of this currency isn’t related to any other currency. Instead, it is determined by how much people are willing to pay for it on the foreign exchange market (market forces of Demand and Supply)

○ Commonly used by the larger currencies, such as the U.S dollar and the Euro.

Example: Foreign Exchange Market for US Dollars relative to Euros.


X-axis: Quantity of dollars that can be exchanged

Y-axis: Exchange Rate (# of Euros per Dollar)

Downward sloping demand, Upward sloping supply

American supply dollars, Europeans demand dollars

Market equilibrium: Exchange rate

● Shifters (Non-Price determinants) of Demand for Foreign currency:

○ Taste and Preferences

○ Income

○ Price Level

○ Interest Rates

● Appreciation: When the value of one currency increases in terms of another currency (Righward shift of demand curve)

○ Eg. If the ratio between USD and CAD changes from $1.00 : $1.37 to $1.00 : $1.50, the Canadian Dollar appreciates against the US Dollar. Now, more US dollars are received for each Canadian Dollar.

● Depreciation: When the value of one currency decreases in terms of another currency (Leftward shift of demand curve)

○ Eg. If the ratio between USD and CAD changes from $1.00 : $1.37 to $1.00 : $1.25, the Canadian Dollar depreciates against the US Dollar. Now, fewer US dollars are received for each Canadian Dollar.

● It is generally agreed upon that appreciation is more desirable. Some of the benefits are:

○ Less expensive imports

○ Travelling abroad would be less expensive

● However, depreciation can also be beneficial sometimes. Some benefits include:

○ Higher net exports

■ This country will export more since the other country’s currency is worth more

■ This country will import fewer goods since it’s currency is worth less.

■ ↑Exports + ↓Imports = ↑Net Exports

○ Travelling will be cheaper for tourists in your country.

● Both falling and rising exchange rates can be harmful to an economy as well.

○ Cons of falling exchange rates

■ If it occurs during a boom (period of growth), it may lead to inflation.

■ Imports become more expensive.

■ Living standards are reduced since everything is more expensive.

○ Cons of rising exchange rates

■ Exporters may find it difficult to compete due to the fall in the value of their currency

● Changes in exchange rates can influence economies in a number of ways:

○ Can have an effect on the demand for exports and imports; appreciation can make it less expensive to import goods since not as much will have to paid, and the opposite is true for depreciation.

○ Depreciation can be an indicator of inflation (If it happens at a large extent)

■ Eg. The incredibly high exchange rate between the USD and Zimbabwean currency was a validation of hyperinflation in Zimbabwe.

○ Public Debt: Nations with large public deficits are less likely to attract foreign investors and thus find it difficult to pay them off. This failure can lead to inflation in order to pay off any debt. However, they will eventually be paid off with less valuable currencies in the future (Thus lowering the exchange rate once again).

Citations

http://www.messerep.victoriaparkci.ca/economics/International%20trade.html

International Economics and Development. P. Messere, n.d. Web. 12 June 2017.

https://www.brightknowledge.org/knowledge-bank/business-and-finance/features-and-resources/how-do-exchange-rates-work

"How do exchange rates work?" How do exchange rates work? — Brightside. N.p., n.d. Web. 12 June 2017.

http://www.economicshelp.org/macroeconomics/exchangerate/factors-influencing/

"Factors which influence the exchange rate." Economics Help. N.p., n.d. Web. 12 June 2017.

https://www.youtube.com/watch?v=_pL_5trI6YY

ACDCLeadership. "Floating vs. Fixed Exchange Rates- Macroeconomics 5.4." YouTube. YouTube, 10 Nov. 2014. Web. 12 June 2017.

http://www.investopedia.com/terms/e/exchangerate.asp

Picardo, CFA Elvis. "Exchange Rate." Investopedia. N.p., 10 Feb. 2017. Web. 12 June 2017.