Foreign Exchange Rates Flexible Exchange Rates Uses demand and supply to determine the value of one...

Foreign Exchange RatesForeign Exchange Rates

Flexible Exchange Rates• Uses demand and supply to determine the value of one nation’s

currency compared to another nation’s

• Equilibrium is the current exchange rate

• Method used by most nations to determine the value of their currency internationally

Lecture 3.2

International Value of a Dollar

• Appreciated– More foreign currency earned per $1 exchanged

– Causes foreign goods to cost less

– Increases imports (foreign-produced goods sold in the U.S.)

• Depreciated– Less foreign currency earned per $1 exchanged

– Causes foreign goods to cost more

– Increases exports (goods made in U.S. sold in foreign countries)

$1 US in foreign currency

2000 2005

Mexican Peso 8 10

British Pound 2 1.5

1. What happened to the value of the US $ compared to the Mexican Peso (appreciate or depreciate)? How do you know?

2. A sombrero in Mexico costs 80 Pesos. How much will it cost• In 2000?• In 2005?

3. What then happens to the amount an American pays for a product when the dollar appreciates?

4. When the dollar appreciates what will happen to U.S.• Imports?• Exports?

5. What happened to the value of the US $ compared to the British Pound? How do you know?• U.S. imports will?• U.S. exports will?

$1 US in foreign currency

2000 2005

Mexican Peso 8 10

British Pound 2 1.5

1. What happened to the value of the US $ compared to the Mexican Peso (appreciate or depreciate)? How do you know? Appreciate; more Pesos received per $1 exchanged (8 Pesos per $ in 2000, 10 Pesos per $ in 2005)

2. A sombrero in Mexico costs 80 Pesos. How much will it cost• In 2000? $80 / 8 Pesos = $10 paid for the sombrero• In 2005? $80 / 10 Pesos = $8 paid for the sombrero

3. What then happens to the amount an American pays for a product when the dollar appreciates? An American pays less since they get more foreign currency per $1

4. When the dollar appreciates what will happen to U.S.• Imports? Increase since they cost less for Americans to buy• Exports? Decrease; Mexicans pay more pesos to get $1

5. What happened to the value of the US $ compared to the British Pound? How do you know? Depreciate; earn less pounds per $1 exchanged in 2005 than 2000• U.S. imports will? ↓ b/c British goods cost U.S. more• U.S. exports will? ↑ b/c British pay less to get each $1 so our goods cost them less