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

New Application of Supply and Demand

The Foreign Exchange Market

FOREX

Supply and Demand and Exchange Rates

• If Americans want to buy foreign goods/services then they need the currency that the people in the foreign country use from day to day.

• If Foreigners want to buy American made goods/services, then they need the currency that people in the U.S. use from day to day.– This currency exchange MUST be made somewhere

along the process of trade!!Currency (money) is a commodity just like any other

good/service – its value is determined by the forces of supply and demand – we can’t escape it!!

There are two major reasons for exchanging currencies

• A desire to buy the goods/services of a foreign supplier.– Change in Tastes– Change in Quality– Change in relative price levels– Change in relative wealth (GDP)

• A relative change in Interest Rates that investors can earn.

Change in Tastes effect on the Exchange Rate

• Suppose Foreigners want the latest computer produced by Dell Computers.

– To do this they will need U.S. dollars because Dell computer wants dollars, not Euros, Pesos, Yen, Yuan, etc.

• Foreigners will have to exchange their currency for dollars. The Supply of the Foreign Currency in the currency market will INCREASE as Foreigners give up their currency and increase their DEMAND for U.S. Dollars.

Market for Euros

Dollar PricePer Euro

$*

€*

Demand for Euros

Supply of Euros

Exchange Rate

Quantity of Euros

$1

€1

S€1

Quantity of Dollars

Exchange Rate

Market for Dollars

Euro PricePer Dollar

€*

$*

Demand for Dollars

Supply of Dollars

€1

$1

D$1

What is the effect on the Exchange Rate?

• The Dollar price per Euro decreases (it becomes cheaper for us to buy) and the Euro Price per Dollar increases (it becomes more expensive for Europeans to buy dollars)

• The Dollar has APPRECIATED in value relative to the foreign currency.– We can purchase more goods from the

Europeans because the dollar buys more of their currency.

What effect does the exchange rate between currencies have on Exports

and/or Imports?

• If the price of a dollar RISES relative to a foreign currency then it is said that the Dollar has APPRECIATED (gotten stronger) in value.

– The dollar can now purchase more of the foreign currency than it could before. Foreign goods are now less expensive because our dollars can now purchase more of their goods than before. On the other hand, foreign currencies have DEPRECIATED in value relative to the dollar so our currency is more expensive to buy and our goods become relatively more expensive for foreigners to buy.

IMPORTS WILL INCREASE AND EXPORTS WILL DECREASE WHEN THE DOLLAR

APPRECIATES IN VALUE RELATIVE TO OTHER CURRENCIES

Interest Rate effect on the Exchange Rate

• Suppose the Interest Rate in U.S. is HIGHER relative to the Interest Rate in the Rest of the World.

– Foreigners will want to invest in the U.S because they can get a higher interest rate. To do this they will need U.S. dollars.

• Supply of the Foreign Currency in the currency market will INCREASE as Foreigners give up their currency and increase their DEMAND for U.S. Dollars.

Market for Euros


$*

€*

Demand for Euros

Supply of Euros

Exchange Rate

Quantity of Euros

$1

€1

S€1

Quantity of Dollars

Exchange Rate

Market for Dollars


€*

$*

Demand for Dollars

Supply of Dollars

€1

$1

D$1


• The Dollar price per Euro decreases (it becomes cheaper for us to buy) and the Euro Price per Dollar increases (it becomes more expensive for Europeans to buy dollars)

• The Dollar has APPRECIATED in value relative to the foreign currency.– We can purchase more goods from the

Europeans because the dollar buys more of their currency.


and/or Imports?

• If the price of a dollar RISES relative to a foreign currency then it is said that the Dollar has APPRECIATED (gotten stronger) in value.

– The dollar can now purchase more of the foreign currency than it could before. Foreign goods are now less expensive because our dollars can purchase more of their goods. On the other hand, foreign currencies have DEPRECIATED in value relative to the dollar so our currency is more expensive to buy and our goods become relatively more expensive for foreigners to buy.

IMPORTS WILL INCREASE AND EXPORTS WILL DECREASE WHEN THE DOLLAR

APPRECIATES IN VALUE RELATIVE TO OTHER CURRENCIES

Change in Tastes effect on the Exchange Rate

• Suppose Americans develop a taste for a vintage wine produced and sold in France.

– To do this they will need Euros because the French wine producers want Euros, not Dollars.

• Americans will have to exchange their currency for Euros. The Supply of the Dollars in the currency market will INCREASE as Americans give up their currency and increase their DEMAND for Euros.

Quantity of Dollars

Exchange Rate

Market for Dollars


€*

$*

Demand for Dollars

Supply of Dollars

€1

$1

S$1

Market for Euros


$*

€*

Demand for Euros

Supply of Euros

Exchange Rate

Quantity of Euros

$1

€1

D€1


• The Dollar price per Euro increases (it becomes more expensive for us to buy) and the Euro Price per Dollar decreases (it becomes less expensive for Europeans to buy dollars)

• The Dollar has DEPRECIATED in value relative to the foreign currency.– We can purchase fewer goods from the

Europeans because the dollar buys less of their currency.


and/or Imports?• If the price of a dollar is LOWER relative to a

foreign currency then it is said that the Dollar has DEPRECIATED (gotten weaker) in value.

– The dollar can now purchase less of the foreign currency than it could before. Foreign goods are now more expensive because our dollars can purchase less of their goods. On the other hand, foreign currencies have APPRECIATED in value relative to the dollar so our currency is less expensive to buy and our goods become relatively cheaper for foreigners to buy.

IMPORTS WILL DECREASE AND EXPORTS WILL INCREASE WHEN THE DOLLAR

DEPRECIATES IN VALUE RELATIVE TO OTHER CURRENCIES

Interest Rate effect on the Exchange Rate

• Suppose the Interest Rate in U.S. is LOWER relative to the Interest Rate in the Rest of the World.

– Americans will want to invest in the country paying a higher interest rate. To do this they will need the foreign currency.

• Supply of U.S. Dollars in the currency market will INCREASE as Americans give up dollars and increase their DEMAND for the foreign currency.

Quantity of Dollars

Exchange Rate

Market for Dollars


€*

$*

Demand for Dollars

Supply of Dollars

€1

$1

S$1

Market for Euros


$*

€*

Demand for Euros

Supply of Euros

Exchange Rate

Quantity of Euros

$1

€1

D€1


• The Dollar price per Euro increases (it becomes more expensive for us to buy) and the Euro Price per Dollar decreases (it becomes less expensive for Europeans to buy dollars)

• The Dollar has DEPRECIATED in value relative to the foreign currency.– We can purchase fewer goods from the

Europeans because the dollar buys less of their currency.


and/or Imports?• If the price of a dollar is LOWER relative to a

foreign currency then it is said that the Dollar has DEPRECIATED (gotten weaker) in value.

– The dollar can now purchase less of the foreign currency than it could before. Foreign goods are now more expensive because our dollars can purchase less of their goods. On the other hand, foreign currencies have APPRECIATED in value relative to the dollar so our currency is less expensive to buy and our goods become relatively cheaper for foreigners to buy.

IMPORTS WILL DECREASE AND EXPORTS WILL INCREASE WHEN THE DOLLAR

DEPRECIATES IN VALUE RELATIVE TO OTHER CURRENCIES

Demand

Supply

P*

Q*

Demand

Supply

P*

Q*

Price of U.S. goods rise relative to German goods.

Quantity of Dollars Quantity of EurosRationale: 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*

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*

French tourist flock to Mexican beaches

Quantity of Euros Quantity of Pesos

Rationale:

Demand

Supply

P*

Q*

Demand

Supply

P*

Q*

Japanese video games become popular with American children

Quantity of Dollars Quantity of Yen

Rationale:

Demand

Supply

P*

Q*

Demand

Supply

P*

Q*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*Quantity of Dollars Quantity of Yen

Japan’s Real GDP increases

U.S. Exports increase or decreaseU.S. Imports increase or decrease

Demand

Supply

P*

Q*

Demand

Supply

P*

Q*

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*

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*

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:

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.

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.

Demand$

Supply$

__price Of $$*

Q$*

Demand____

Supply__$$priceof__*

Q__*

• Demand/Supply for $$ – Increase or Decrease

• ___Price of $$ --• Increase or Decrease

• $$ --Depreciate or Appreciate

• $$ -- Weaker or Stronger

• U.S. Imports -----Increase or Decrease

• U.S. Exports------Increase or Decrease

• Demand/Supply for _____ – Increase or Decrease

• $$ Price of ______ • Increase or Decrease

• ____Depreciate or Appreciate

• ____Weaker or Stronger

• ___Imports -----Increase or Decrease

• ____Exports------Increase or Decrease

Quantity of Dollars Quantity of ____________

U.S. NET EXPORTS -----INCREASE OR DECREASE

€1.00 $1.00

Market for $ Market for €

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.

USD $50,000 = EURO €50,000



$1.35 = € 1.00 (dollar price (cost) per euro is $1.35)or

€.74 = $1.00 (euro price (cost) per dollar is €.74)



$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

€ 37,037If 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

$67,567Where do Americans want to buy their Mercedes?

In U.S.Where do Germans want to buy their Mercedes?

In U.SWhat happens to Exports from U.S


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.

Demand$

Supply$

__price Of $$

Q$*

Demand____

Supply__

$$priceof__

Q__*

• Demand/Supply for $$ – Increase or Decrease




• U.S. Imports -----Increase or Decrease

• U.S. Exports------Increase or Decrease





• ___Imports -----Increase or Decrease

• ____Exports------Increase or Decrease



____ ____

Market for $ Market for ____

Circle correct answers Circle correct answers

USD $50,000 = EURO €50,000



or



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


USD $50,000 = EURO €50,000



$.75 = € 1.00 (dollar price (cost) per euro is $.75)or

€.1.33 = $1.00 (euro price (cost) per dollar is €.1.33)



$50,000 = No. of Euros needed x $.75 (for each Euro exchanged he can get $.75$50,000 / $.75 = No. of Euros needed

€ 66,667If 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

$37,594Where do Americans want to buy their Mercedes?

In Germany.Where do Germans want to buy their Mercedes?

In Germany

What happens to Exports from U.S?

What happens to Imports to U.S?

• Demand for $$ -- Increase or Decrease

• Price of $$ -- Increase or Decrease



• Imports -----Increase or Decrease

• Exports------Increase or Decrease

• Demand for _____ Increase or Decrease

• Price of ________ Increase or Decrease





Quantity of_______ Quantity of ____________


Demand$

Supply$

P$*

Q$*

Demand____

Supply__

P__*

Q__*

• Demand for $$ -- Increase or Decrease

• Price of $$ -- Increase or Decrease





• Demand for _____ Increase or Decrease

• Price of ________ Increase or Decrease







Demand$

Supply$MXN price of $$

Q$*

Demand Peso_

Supply Peso_$$priceof 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 ofpesos 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 willneed 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

AB

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 inthe 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)

Qp1Q$1

Demand$

Supply$___ price of $$

Demand ____

Supply ___$$priceof ___

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)

Quantity of Dollars

Exchange Rate

Market for Dollars


€*

$*

Demand for Dollars

Supply of Dollars

Demand$

Supply$

__price Of $*

Q$*

Demand____

Supply__$ priceof__*

Q__*

• Demand/Supply for $$ – - Increase or Decrease














• Demand/Supply for $$ – - Increase or Decrease











• Exports------Increase or DecreaseU.S. NET EXPORTS -----INCREASE OR DECREASE


• The Interest Rates in the U.S. are higher relative to the Interest Rates in Europe . • On the above graphs show me how this will effect supply and demand in the Market for Dollars and the Market for

Euros. Don’t forget to properly label!! In the space below, tell me “the story” of what is going on. Be sure to include what happens to the value of both currencies and the reason we had a movement in the exchange rate. Tell me what the potential effect on Imports and Exports will be after the change in the exchange rate. Use the back of this page if you need more space. Be as complete as possible. Use all the terms we have studied (i.e. stronger/weaker, appreciate/depreciate, increase/decrease. Etc)


• The Interest Rates in the U.S. are lower relative to the Interest Rates in Europe . • On the above graphs show me how this will effect supply and demand in the Market for Dollars and the Market for

Euros. Don’t forget to properly label!! In the space below, tell me “the story” of what is going on. Be sure to include what happens to the value of both currencies and the reason we had a movement in the exchange rate. Tell me what the potential effect on Imports and Exports will be after the change in the exchange rate. Use the back of this page if you need more space. Be as complete as possible. Use all the terms we have studied (i.e. stronger/weaker, appreciate/depreciate, increase/decrease. Etc)


• French parents hear about a great home-schooling program in Argyle, Tx and they want to come and see what it is all about. How, in some small way might this effect the FOREX market.

• On the above graphs show me how this will effect supply and demand in the Market for Dollars and the Market for Euros. Don’t forget to properly label!! In the space below, tell me “the story” of what is going on. Be sure to include what happens to the value of both currencies and the reason we had a movement in the exchange rate. Tell me what the potential effect on Imports and Exports will be after the change in the exchange rate. Use the back of this page if you need more space. Be as complete as possible. Use all the terms we have studied (i.e. stronger/weaker, appreciate/depreciate, increase/decrease. Etc)


• The Japanese discover a method to cure male patterned baldness in Middle-aged men. The cure comes from an herb grown only in Japan and it is only available in Japan. Mr. Hayward and several million other American men are VERY interested in this cure. How, in some small way, might this effect the FOREX market.

• On the above graphs show me how this will effect supply and demand in the Market for Dollars and the Market for YEN. Don’t forget to properly label!! In the space below, tell me “the story” of what is going on. Be sure to include what happens to the value of both currencies and the reason we had a movement in the exchange rate. Tell me what the potential effect on Imports and Exports will be after the change in the exchange rate. Use the back of this page if you need more space. Be as complete as possible. Use all the terms we have studied (i.e. stronger/weaker, appreciate/depreciate, increase/decrease. Etc)

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

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