Chapter 25 Economics: Exchange Rates | Quizlet

What is the foreign exchange market?

The forex market is where currencies are traded globally.

What type of market structure does the forex market resemble?

The forex market is considered the closest to a perfectly competitive market.

What are the key characteristics of the forex market?

Perfect competition, continuous operation (24/7), and accessibility for currency conversion.

Who are the main stakeholders in the foreign exchange market?

Individual traders, forex brokers, central banks, remittance companies, investment banks, and speculators.

What is the difference between buying and selling prices in the forex market called?

Spreads.

How can the forex market be illustrated?

Using a demand and supply diagram.

What does the y-axis represent in a forex demand and supply diagram?

The exchange rate of one currency in terms of another (e.g., X/Y refers to the amount of currency X needed to buy 1 unit of currency Y).

What does the x-axis represent in a forex demand and supply diagram?

The quantity of currency Y traded for currency X.

What does the demand curve represent in a forex diagram? (Market for currency Y)

People holding currency X who want to exchange it for currency Y.

What does the supply curve represent in a forex diagram? (Market for currency Y)

People holding currency Y who want to exchange it for currency X.

How do you calculate the amount of currency Y needed to buy 1 unit of currency X when give the opposite (X/Y)

1 ÷ (X/Y) = Y/X.

What happens in the forex market when there is an increase in interest rates in country Y?

The demand for currency Y increases, leading to appreciation of currency Y and depreciation of currency X.

What happens in the forex market when there is a decrease in interest rates in country Y?

The demand for currency Y decreases, leading to depreciation of currency Y and appreciation of currency X.

What are the three main types of exchange rate systems?

Floating exchange rates, fixed exchange rates, and managed exchange rates.

What determines the value of a currency in a floating exchange rate system?

The free market forces of supply and demand.

What happens when the demand for a currency increases in a floating exchange rate system?

The currency appreciates.

What happens when the supply of a currency increases in a floating exchange rate system?

The currency depreciates.

What is the equilibrium exchange rate?

The rate at which the quantity demanded of one currency equals the quantity supplied of another currency.

What is appreciation in a floating exchange rate system?

The rise in the value of a currency.

What is depreciation in a floating exchange rate system?

The fall in the value of a currency.

What causes the appreciation of currency Y?

An increase in demand for currency Y or a decrease in its supply.

What causes the depreciation of currency Y?

A decrease in demand for currency Y or an increase in its supply.

What is a fixed exchange rate system?

An exchange rate system where the central bank or government fixes the value of the currency to another currency or standard.

How can a central bank maintain a fixed exchange rate?

By buying or selling foreign reserves, changing interest rates, or imposing import controls.

What is devaluation in a fixed exchange rate system?

The lowering of the fixed value of a currency against another currency.

What is revaluation in a fixed exchange rate system?

The raising of the fixed value of a currency against another currency.

What is a managed exchange rate system?

A system where currency value is mostly determined by market forces, with occasional central bank intervention to prevent large fluctuations.

What is an overvalued currency?

A currency managed at a value higher than its true floating exchange rate value.

What is an undervalued currency?

A currency managed at a value lower than its true floating exchange rate value.

What are the impacts of currency appreciation on trade balance and economic growth?

Appreciation makes exports more expensive and imports cheaper, worsening the trade balance and reducing economic growth.

What are the impacts of currency depreciation on trade balance and economic growth?

Depreciation makes exports cheaper and imports more expensive, improving the trade balance and increasing economic growth.

What is the impact of exchange rate changes on inflation?

Appreciation lowers import costs and reduces inflation, while depreciation increases import costs and may cause demand-pull and cost-push inflation.

What are the advantages of fixed exchange rate systems?

Stability, reduced speculative risks, and encouragement of foreign direct investment.

What are the disadvantages of fixed exchange rate systems?

Opportunity costs, reduced currency liquidity, and limited monetary policy flexibility.

How does central bank intervention affect a managed exchange rate system?

It can prevent excessive fluctuations by buying or selling foreign reserves to adjust currency supply and demand.

What is the "crawling peg" in managed exchange rate systems?

A system where the central bank sets upper and lower bounds for exchange rates, allowing gradual adjustments.

What factors influence whether a currency appreciates or depreciates?

Changes in interest rates, inflation, demand for exports, investment flows, remittances, and speculation.

How do changing exchange rates impact employment?

Appreciation can reduce exports and increase unemployment, while depreciation can boost exports and reduce unemployment.

What is the role of foreign direct investment (FDI) in exchange rate movements?

FDI increases demand for the currency of the country receiving the investment.