Foreign Exchange FOREX

Foreign Exchange (FOREX) - The buying/selling of currency

• Ex. In order to purchase souvenirs in France, it is first necessary for Americans to sell (supply) their dollars and buy (demand) Euros

• The exchange rate (e) is determined in the foreign currency markets
1. Ex. The current exchange rate is approximately 77 Japanese Yen to 1 US dollar.  
• Exchange rate is price of a currency

4 Important Tips

• Always change the D line on one currency graph, the S line on the other currency's graph

• Move the lines of the two currency graphs in the same direction (right or left) and you have correct answer)

• If D on one graph increases, S on the other will also increase

• If D moves left, S moves left on other graph

Changes in Exchange Rates

• Exchange rates (e) are a function of the supply and demand for currency
1. An increase in supply of currency makes it cheaper to buy one unit of it, vice versa for a decrease in supply
2. An increase in demand of currency will make buying one unit more expensive, vice versa for decrease in demand

• Appreciation - Occurs when the exchange rate of that currency increases (e increases)

• Depreciation - Occurs when exchange rate of that currency decreases (e decreases)

Determinants of Exchange Rate

• Consumer Tastes
1. Ex. A preference for Japanese goods creates an increase in demand of Yen and an increase in the supply of the dollar

• Relative Economy
1. Imports tend to be normal goods
2. Ex. if Mexico's economy is becoming stronger and the U.S. Economy is in recession, Mexicans will buy more of everything including American goods
3. Increases demand for dollar, causing dollar to appreciate and the peso to depreciate

• Relative Price Level
1. If PL is higher in Canada than in US, American "g"

• Speculation
1. Other currency will appreciate as demand for it increases
2. Supply of dollar will increase causing it to depreciate