The document discusses how exchange rates between currencies are determined by the forces of supply and demand in foreign exchange markets. There are two main reasons for exchanging currencies: to purchase goods/services from another country or relative changes in interest rates between countries. If demand for a currency increases due to a change in tastes, interest rates, or other economic factors, its value will appreciate as its price in the foreign exchange market rises. An appreciating currency makes imports less expensive and exports more expensive, decreasing exports and increasing imports.

1. New Application of Supply and Demand The Foreign Exchange Market FOREX

5. Market for Euros Dollar Price Per Euro $* € * Demand for Euros Supply of Euros Exchange Rate Quantity of Euros $ 1 € 1 S € 1

6. Quantity of Dollars Exchange Rate Market for Dollars Euro Price Per Dollar € * $* Demand for Dollars Supply of Dollars € 1 $ 1 D$ 1

10. Market for Euros Dollar Price Per Euro $* € * Demand for Euros Supply of Euros Exchange Rate Quantity of Euros $ 1 € 1 S € 1

11. Quantity of Dollars Exchange Rate Market for Dollars Euro Price Per Dollar € * $* Demand for Dollars Supply of Dollars € 1 $ 1 D$ 1

15. Quantity of Dollars Exchange Rate € 1 $ 1 S$ 1 Market for Dollars Euro Price Per Dollar € * $* Demand for Dollars Supply of Dollars

16. Market for Euros Dollar Price Per Euro $* € * Demand for Euros Supply of Euros Exchange Rate Quantity of Euros $ 1 € 1 D € 1

20. Quantity of Dollars Exchange Rate € 1 $ 1 S$ 1 Market for Dollars Euro Price Per Dollar € * $* Demand for Dollars Supply of Dollars

21. Market for Euros Dollar Price Per Euro $* € * Demand for Euros Supply of Euros Exchange Rate Quantity of Euros $ 1 € 1 D € 1

25. Price of U.S. goods rise relative to German goods. Quantity of Dollars Quantity of Euros Rationale: Americans will demand less expensive Germans goods thereby increasing the demand for Euros and increasing the supply of dollars to the FOREX. The U.S. dollars depreciates and the Euro appreciates Demand Supply P* Q* Demand Supply P* Q*

26. Interest rates in the U.S rise faster than interest rates in Canada Quantity of Dollars Quantity of Canadian Dollars Rationale: Demand Supply P* Q* Demand Supply P* Q*

28. French tourist flock to Mexican beaches Quantity of Euros Quantity of Pesos Rationale: Demand Supply P* Q* Demand Supply P* Q*

29. Japanese video games become popular with American children Quantity of Dollars Quantity of Yen Rationale: Demand Supply P* Q* Demand Supply P* Q*

32. Quantity of Dollars Quantity of Yen What happens to the U.S. Dollar: What happens to the Japanese Yen: Japan’s Real GDP increases Demand Supply P* Q* Demand Supply P* Q*

33. Quantity of Dollars Quantity of Yen Japan’s Real GDP increases U.S. Exports increase or decrease U.S. Imports increase or decrease Demand Supply P* Q* Demand Supply P* Q*

35. Interest rates in the U.S increase Quantity of Dollars Quantity of Euros What happens to the U.S. Dollar: What happens to the Euro: Demand Supply P* Q* Demand Supply P* Q*

36. Interest rates in Europe increase Quantity of Dollars Quantity of Euros U.S. Exports increase or decrease: U.S. Imports increase or decrease: Demand Supply P* Q* Demand Supply P* Q*

38. The price level in Canada increases Quantity of Dollars Quantity of Canadian Dollars What happens to the U.S. dollar: What happens to the Canadian Dollar: Demand Supply P* Q* Demand Supply P* Q*

39. FOREX – Example Assumption – Mercedes Benz makes cars in both the U.S. and Germany. Lets say that yesterday the exchange rate between the $ and the € is $1.00 equals € 1.00. To buy a Mercedes costs $50,000 or € 50,000. You are indifferent to who sells you the car. In the paper today you find out the U.S. interest rate relative to the interest rate in Europe is LOWER. You check the FOREX and you find out that the exchange rate is now EURO/USD is $1.35. Use the following worksheet to graph what happened in the FOREX market and answer the questions that follow. Assumption – Mercedes Benz makes cars in both the U.S. and Germany. Lets say that yesterday the exchange rate between the $ and the € is $1.00 equals € 1.00. To buy a Mercedes costs $50,000 or € 50,000. You are indifferent to who sells you the car. In the paper today you find out the U.S. interest rate relative to the interest rate in Europe is HIGHER. You check the FOREX and you find out that the exchange rate is now EURO/USD is $.75. Use the following worksheet to graph what happened in the FOREX market and answer the questions that follow.

40. FOREX – Example Assumption – Mercedes Benz makes cars in both the U.S. and Germany. Lets say that yesterday the exchange rate between the $ and the € is $1.00 equals € 1.00. To buy a Mercedes costs $50,000 or € 50,000. You are indifferent to who sells you the car. In the paper today you find out the U.S. interest rate relative to the interest rate in Europe is LOWER . You check the FOREX and you find out that the exchange rate is now USD/EURO is $1.35 (dollar price (cost) per euro is $1.35). Use the following worksheet to graph what happened in the FOREX market and answer the questions that follow.

42. USD $50,000 = EURO €50,000 Exchange Rate was $1.00 = €1.00 Exchange Rate is now or How much does that Mercedes cost now in each currency for an American to buy and a German to buy? If you are a German and you convert your Euros to Dollars that Mercedes will cost you: If you are an American and you convert your Dollars to Euros that Mercedes will cost you: Where do Americans want to buy their Mercedes? Where do Germans want to buy their Mercedes? What happens to Exports from U.S What happens to Imports to U.S.

43. USD $50,000 = EURO €50,000 Exchange Rate was $1.00 = €1.00 Exchange Rate is now $1.35 = € 1.00 (dollar price (cost) per euro is $1.35) or €.74 = $1.00 (euro price (cost) per dollar is €.74) How much does that Mercedes cost now in each currency for an American to buy and a German to buy? If you are a German and you convert your Euros to Dollars that Mercedes will cost you: $50,000 = No. of Euros needed x $1.35 (for each Euro exchanged he can get $1.35) $50,000 / $1.35 = No. of Euros needed € 37,037 If you are an American and you convert your Dollars to Euros that Mercedes will cost you: € 50,000 = No. of Dollars needed x €.74 (for each Dollar exchanged he can get €.74) € 50,000 / €.74= No. of Dollars needed $67,567 Where do Americans want to buy their Mercedes? In U.S. Where do Germans want to buy their Mercedes? I n U.S What happens to Exports from U.S What happens to Imports to U.S.

44. FOREX – Example Assumption – Mercedes Benz makes cars in both the U.S. and Germany. Lets say that yesterday the exchange rate between the $ and the € is $1.00 equals € 1.00. To buy a Mercedes costs $50,000 or € 50,000. You are indifferent to who sells you the car. In the paper today you find out the U.S. interest rate relative to the interest rate in Europe is HIGHER . You check the FOREX and you find out that the exchange rate is now USD/EURO is $.75 (dollar price (cost) per euro is $.75). Use the following worksheet to graph what happened in the FOREX market and answer the questions that follow.

46. USD $50,000 = EURO €50,000 Exchange Rate was $1.00 = €1.00 Exchange Rate is now or How much does that Mercedes cost now in each currency for an American to buy and a German to buy? If you are a German and you convert your Euros to Dollars that Mercedes will cost you: If you are an American and you convert your Dollars to Euros that Mercedes will cost you: Where do Americans want to buy their Mercedes? Where do Germans want to buy their Mercedes? What happens to Exports from U.S What happens to Imports to U.S.

47. USD $50,000 = EURO €50,000 Exchange Rate was $1.00 = €1.00 Exchange Rate is now $.75 = € 1.00 (dollar price (cost) per euro is $.75) or €.1.33 = $1.00 (euro price (cost) per dollar is €.1.33) How much does that Mercedes cost now in each currency for an American to buy and a German to buy? If you are a German and you convert your Euros to Dollars that Mercedes will cost you: $50,000 = No. of Euros needed x $.75 (for each Euro exchanged he can get $.75 $50,000 / $.75 = No. of Euros needed € 66,667 If you are an American and you convert your Dollars to Euros that Mercedes will cost you: € 50,000 = No. of Dollars needed x €1.33 (for each Dollar exchanged he can get €1.33) € 50,000 / €1.33= No. of Dollars needed $37,594 Where do Americans want to buy their Mercedes? In Germany. Where do Germans want to buy their Mercedes? I n Germany What happens to Exports from U.S? What happens to Imports to U.S?

51. Demand$ Supply$ MXN price of $$ Q$* Demand Peso_ Supply Peso _ $$price of MXN_ Q P* Quantity of Dollars Quantity of Pesos 10 P $.10 Market for $ Market for Pesos_ (ii) In the market for dollars the demand for dollars will increase because the Mexican govt. wants to buy American made computers and they will need dollars which they don’t have. Because of the increase in demand, relative to the supply for the dollar, the dollar has now appreciated (stronger) in value relative to the peso. For Mexicans it will now take more pesos for them to buy a dollar. In the market for pesos the supply of pesos will increase because the Mexican govt. wants to buy American made computers and they need to give up pesos in order to get dollars. Because of the increase in supply, relative to the demand for the peso, the peso has now depreciated (weaker) in value relative to the dollar. For Americans it will now take fewer dollars (cents) for us to buy a peso. (C) The cost of a trip to Mexico will be less expensive when I exchange my dollars for pesos. Because the dollar has appreciated in value, I will now receive more pesos for each dollar that I exchange. Therefore I will need fewer dollars to exchange for pesos than I would have needed before he Mexican government took their action. D$1 Speso1 $.08 12.5 P A B A B Note: The numbers on the vertical axis were derived this way: I was given equilibrium price in the example. After I shifted my curves I can see that in the market for pesos the new price is going to be lower than $.10. I chose $.08 as the new price. In the market for dollars I know the new price is going to be above 10 peso. I can find what that number is by taking the reciprocal of $.08 which equals 12.5. (A) Qp1 Q$1

52. Demand$ Supply$ ___ price of $$ Demand ___ _ Supply __ _ $$price of ___ Quantity of Dollars Quantity of ______ Market for $ Market for _____ (ii) In the market for dollars the ______ for dollars will _______ because ________________________________________and _______________Because of the ________ in __________, relative to the __________ for the dollar, the dollar has now ___________________ in value relative to the _______. For _______________ it will now take ____ _____ for them to buy a dollar. In the market for ______ the ________ for ________ will __________ because ______________________. Because of the _______ in ________, relative to the ________ for the _____ the ______ has now __________________ in value relative to the dollar. For Americans it will now take ______ ________ for us to buy a _______. (C) The cost of a trip to __________ will be _______expensive when I exchange my dollars for ______. Because the dollar has _________ in value, I will now receive _______ ________ for each dollar that I exchange. Therefore I will need _______ dollars to exchange for ______ than I would have needed before the scenario stated in the problem. D$1 (A)

54. Demand$ Supply$ ___ price of $$ Demand ___ _ Supply __ _ $$price of ___ Quantity of Dollars Quantity of ______ Market for $ Market for _____ (ii) In the market for dollars the ______ for dollars will _______ because ________________________________________and _______________Because of the ________ in __________, relative to the __________ for the dollar, the dollar has now ___________________ in value relative to the _______. For _______________ it will now take ____ _____ for them to buy a dollar. In the market for ______ the ________ for ________ will __________ because ______________________. Because of the _______ in ________, relative to the ________ for the _____ the ______ has now __________________ in value relative to the dollar. For Americans it will now take ______ ________ for us to buy a _______. (C) The cost of a trip to __________ will be _______expensive when I exchange my dollars for ______. Because the dollar has _________ in value, I will now receive _______ ________ for each dollar that I exchange. Therefore I will need _______ dollars to exchange for ______ than I would have needed before the scenario stated in the problem. D$1 (A)

55. Demand$ Supply$ ___ price of $$ Demand ___ _ Supply __ _ $$price of ___ Quantity of Dollars Quantity of ______ Market for $ Market for _____ (ii) In the market for dollars the ______ for dollars will _______ because ________________________________________and _______________Because of the ________ in __________, relative to the __________ for the dollar, the dollar has now ___________________ in value relative to the _______. For _______________ it will now take ____ _____ for them to buy a dollar. In the market for ______ the ________ for ________ will __________ because ______________________. Because of the _______ in ________, relative to the ________ for the _____ the ______ has now __________________ in value relative to the dollar. For Americans it will now take ______ ________ for us to buy a _______. (C) The cost of a trip to __________ will be _______expensive when I exchange my dollars for ______. Because the dollar has _________ in value, I will now receive _______ ________ for each dollar that I exchange. Therefore I will need _______ dollars to exchange for ______ than I would have needed before the scenario stated in the problem. D$1 (A)

57. Demand$ Supply$ ___ price of $$ Demand ___ _ Supply __ _ $$price of ___ Quantity of Dollars Quantity of ______ Market for $ Market for _____ (ii) In the market for dollars the ______ for dollars will _______ because ________________________________________and _______________Because of the ________ in __________, relative to the __________ for the dollar, the dollar has now ___________________ in value relative to the _______. For _______________ it will now take ____ _____ for them to buy a dollar. In the market for ______ the ________ for ________ will __________ because ______________________. Because of the _______ in ________, relative to the ________ for the _____ the ______ has now __________________ in value relative to the dollar. For Americans it will now take ______ ________ for us to buy a _______. (C) The cost of a trip to __________ will be _______expensive when I exchange my dollars for ______. Because the dollar has _________ in value, I will now receive _______ ________ for each dollar that I exchange. Therefore I will need _______ dollars to exchange for ______ than I would have needed before the scenario stated in the problem. D$1 (A)

58. Demand$ Supply$ ___ price of $$ Demand ___ _ Supply __ _ $$price of ___ Quantity of Dollars Quantity of ______ Market for $ Market for _____ (ii) In the market for dollars the ______ for dollars will _______ because ________________________________________and _______________Because of the ________ in __________, relative to the __________ for the dollar, the dollar has now ___________________ in value relative to the _______. For _______________ it will now take ____ _____ for them to buy a dollar. In the market for ______ the ________ for ________ will __________ because ______________________. Because of the _______ in ________, relative to the ________ for the _____ the ______ has now __________________ in value relative to the dollar. For Americans it will now take ______ ________ for us to buy a _______. (C) The cost of a trip to __________ will be _______expensive when I exchange my dollars for ______. Because the dollar has _________ in value, I will now receive _______ ________ for each dollar that I exchange. Therefore I will need _______ dollars to exchange for ______ than I would have needed before the scenario stated in the problem. D$1 (A)

59. Market for Euros Dollar Price Per Euro $* € * Demand for Euros Supply of Euros Exchange Rate Quantity of Euros

60. Quantity of Dollars Exchange Rate Market for Dollars Euro Price Per Dollar € * $* Demand for Dollars Supply of Dollars

61. Quantity of Dollars Exchange Rate Market for Dollars Euro Price Per Dollar € * $* Demand for Dollars Supply of Dollars

62. Market for Euros Dollar Price Per Euro $* € * Demand for Euros Supply of Euros Exchange Rate Quantity of Euros