Introduction

to Economics:
Social Issues
and Economic
Thinking

Wendy A .
Stock

CHAPTER 13
FOREIGN EXCHANGE AND THE PowerPoint
INTERNATIONAL TRADE OF Prepared by
Z. Pan
MONEY
Copyright © 2013 John Wiley & Sons, Inc. / Photo Credit: ©MARIA TOUTOUDAKI/iStockphoto
 AFTER STUDYING THIS CHAPTER, YOU
SHOULD BE ABLE TO:

➢Understand how foreign exchange markets

operate
➢Demonstrate how foreign exchange rates
are determined
➢Describe how foreign exchange rates
influence international trade

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 FOREIGN EXCHANGE MARKETS

➢The Exchange Rate is the rate at which one

currency can be exchanged for another. It is
usually stated in terms of how many units of
one currency can be bought with one unit of
a different currency.
e.g. 1 USD = 0.71 EUR

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 THE DEMAND AND SUPPLY OF FOREIGN
CURRENCIES

➢The demand for Euros comes from people

who need to exchange U.S. dollars for Euros.
e.g. U.S. importers of French wine or other
products, U.S. tourists, and U.S. investors who want
to invest in French companies.
➢The supply of Euros comes from people and
firms who want to buy U.S. dollars.
e.g. French citizens or businesses want to purchase
U.S. goods and services or travel to the U.S.

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 FOREIGN EXCHANGE MARKET

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 FOREIGN EXCHANGE MARKET

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 CHANGES IN DEMAND AND SUPPLY

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 APPRECIATION VS. DEPRECIATION

➢When the price of currency A rises relative to

currency B, currency A has appreciated.

➢When the price of currency A falls relative to

currency B, currency A has depreciated.

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 CHANGES IN DEMAND AND SUPPLY

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 FACTORS SHIFTING SUPPLY AND DEMAND

➢Tastes and Preferences: Changes in tastes and

preferences for a certain country’s goods and
services can change the demand for that
country’s currency.
➢Income: Assuming that foreign goods and
services are normal (rather than inferior) goods,
increases in people ’s incomes in one country
can increase their demand for foreign goods
and services.

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 FACTORS SHIFTING SUPPLY AND DEMAND

➢Expectations: People’s expectations about

the future influence their demand for goods
and services today.
➢Interest Rates: If interest rate in Europe is
higher than United States, lenders and
investors will increase lending and investing
in Europe, increasing demand for Euros.
➢Risk: If lending in Europe becomes more
risky, lenders will decrease lending and
investing there, decreasing demand for
Euros.
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 INTERNATIONAL TRADE

➢Exports: Goods or services produced

domestically but sold abroad.
➢Imports: Goods or services produced abroad
but sold domestically.
➢Trade surplus: When a country ’s level of
exports exceeds its level of imports.
➢Trade deficit: When a country ’s level of
imports exceeds its level of exports.

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 VALUE OF FOREIGN CURRENCIES &
INTERNATIONAL TRADE

➢A ppreciation of U.S. dollar relative to Euro

will lead to a reduction in U.S. exports to
Europe.
➢Appreciation of U.S. dollar against Euro
simultaneously involves a depreciation of
Euro against U.S. dollar.
➢Depreciation of Euro will lead to an increase
in European exports to the U.S. Ceteris
paribus

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 VALUE OF FOREIGN CURRENCIES &
INTERNATIONAL TRADE

➢De preciation of U.S. dollar against Euro will

lead to an increase in U.S. exports to Europe
and a decrease in U.S. imports from Europe.
➢Depreciation of U.S. dollar against Euro
simultaneously involves an appreciation of
Euro against U.S. dollar.
➢Appreciation of Euro will lead to a decrease
in European exports to the U.S.

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 FIXED AND FLEXIBLE EXCHANGE RATES

➢In Flexible or Floating Exchange Rate

System , exchange rates are determined by
demand and supply in the foreign exchange
markets.
➢In Fixed or Pegged Exchange Rate System,
exchange rates are kept constant through
government action in foreign exchange
markets.

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 FIXED EXCHANGE RATE SYSTEM

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 QUESTIONS/DISCUSSIONS

1. What are the costs and benefits

having a fixed exchange rate system?
2. What are some factors that would
cause an increase in the demand for
Mexican Pesos relative to U.S. dollars?

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 KEY CONCEPTS

• Exchange rate
• Appreciated
• Depreciated
• Exports
• Imports
• Trade surplus
• Trade deficit
• Flexible or floating exchange rate system
• Fixed or pegged exchange rate system

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