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