Unit Seven: Mechanics of Foreign Exchange

Mechanics of Foreign Exchange (FOREX)

Notes from 5/3/16

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

Change in e 

-e are a function of the supply and demand for currency

-An increase in the supply of a currency ---> Decrease in e

-A decrease in the supply of a currency ---> Increase in e

-An increase in the demand of a currency ---> Increase in e

-A decrease in the demand for a currency ---> Decrease in e

Appreciation v. Depreciation

+ Appreciation- Occurs when the e of that currency increases

+ Depreciation- Occurs when the e of that currency decreases

Exchange Rate Determinants

1. Consumer's Tastes

2. Relative Income

3. Relative Price Level

4. Speculation

Exports and Imports

-The e 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, thus 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 increasing imports

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