CHAPTER 3: IN-CLASS EXERCISE IN-CLASS EXERCISE # 1: SUPPLY/DEMAND SCHEDULES IN FX MARKET

List of Graphs: Supply / Demand Curve Shifts in the Foreign Exchange (FX) The table below presents the supply and demand schedules for BP (from the US view point).
Market Price of BP Schedule A (# of BP supplied or demanded) Schedule B (# of BP supplied or demanded)

In each graph, the vertical axis represents the price of FX in US dollars and the horizontal axis $1.40 1,000,000 10,000,000
represents the quantity of FX demanded / supplied. D0 and S0 refer to the initial supply and $1.45 2,000,000 8,000,000
demand schedules while D1 and S1 refer to the initial supply and demand schedules after they $1.50 3,000,000 7,000,000
shift. The arrows indicate the direction of the shift. Please choose the graph (A through H) which
provides the best answer to the question. $1.55 5,000,000 5,000,000

S0 $1.60 6,000,000 4,000,000

(A) (B) (C)
S0 S1 $1.65 7,000,000 3,000,000
S1
S1 S0
a. Identify the:
 Supply schedule: Schedule A / Schedule B
 Demand schedule: Schedule A / Schedule B
D1
D0 D1 b. What would be the clearing price for BP in the foreign exchange market? Why?
D0 c. What would happen if both the US and the British governments fixed the price of BP at
D1 D0 $1.40? Excess supply of BP / Excess demand for BP
d. Calculate the excess supply or demand for BP if both the US and the British governments
fixed the price of BP at $1.65.
S1 IN-CLASS EXERCISE # 2: THE EFFECTS OF ECONOMIC FACTORS IN FX MARKET
(D) (E) S0 (F) S1
S0 Please use the list of graphs to answer questions 1, 3, and 5.
S1 S0
1. If the US inflation rate increased by 2% while the British inflation rate increased by 1%,
identify which graph best describes what happens in the foreign exchange market for BP:

2. If the US inflation rate increased by 2%, while the British inflation rate increased by 3%,
D0
complete each one of the statements below:
D0 D0
D1 a. The demand for BP in the FX market will: increase/decrease/not change
b. The supply of BP in the FX market will: increase/decrease/not change
c. The price of BP in the FX market will: increase/decrease/not change
S0
S0 3. If the US real interest rate increased by 2% while the British real interest rate did not change,
(G) (H)
identify which graph best describes what happens in the foreign exchange market for BP:

4. If the US real interest rate increased by 2% while the British real interest rate increased by 4%,
complete each one of the statements below:
D0
a. The demand for BP in the FX market will: increase/decrease/not change
D1
b. The supply of BP in the FX market will: increase/decrease/not change
D1 c. The price of BP in the FX market will: increase/decrease/not change
D0
5. If the US economy moved into a recession, while the British economy remained the same,
identify which graph best describes what happens in the foreign exchange market for BP.