Topic 6.5: Changes in the Foreign Exchange Market and Net Exports

Topic 6.5: Changes in the Foreign Exchange Market and Net Exports Definition:

Changes in exchange rates impact a country’s net exports (exports minus imports) and aggregate demand. Currency appreciation and depreciation alter the competitiveness of goods and services in the global market.

Key Concepts to Remember:

1. Currency Appreciation:

● A country’s currency becomes more valuable relative to another.

● Effects on Trade:

● Exports decrease (goods become more expensive for foreign buyers).

● Imports increase (foreign goods become cheaper for domestic consumers).

● Net Exports (Xn): Decrease.

● Effects on Aggregate Demand (AD):

● Lower net exports reduce aggregate demand.

2. Currency Depreciation:

● A country’s currency becomes less valuable relative to another.

● Effects on Trade:

● Exports increase (goods become cheaper for foreign buyers).

● Imports decrease (foreign goods become more expensive for domestic consumers).

● Net Exports (Xn): Increase.

● Effects on Aggregate Demand (AD):

● Higher net exports increase aggregate demand.

Key Terms to Know:

● Net Exports (Xn): The value of exports minus imports.

● Aggregate Demand (AD): The total demand for goods and services in an economy.

● Appreciation: A rise in the value of a currency relative to another.

● Depreciation: A fall in the value of a currency relative to another.

Factors Influencing Exchange Rates and Net Exports:

1. Demand for Domestic Goods:

● Higher demand for a country’s goods → Currency appreciates → Exports decrease.

2. Interest Rates:

● Higher interest rates attract foreign investment → Currency appreciates → Net exports decrease.

3. Speculation:

● If investors expect a currency to appreciate, demand increases → Appreciation occurs.

4. Inflation Rates:

● Higher inflation makes domestic goods less competitive → Exports decrease → Net exports

decrease.

Graphs and Models to Know:

1. Exchange Rate Changes:

● X-Axis: Quantity of currency.

● Y-Axis: Exchange rate.

● Currency appreciation shifts demand for domestic goods left or supply of foreign currency right.

2. Aggregate Demand:

● Show how changes in net exports shift the AD curve:

● Net Exports Increase: AD shifts right.

● Net Exports Decrease: AD shifts left.

Examples of Economic Impact:

1. Appreciation Example:

● The U.S. dollar appreciates:

● U.S. cars become more expensive in Europe → Exports decrease.

● Foreign electronics become cheaper in the U.S. → Imports increase.

● Net exports decrease → AD shifts left.

2. Depreciation Example:

● The euro depreciates:

● European wines become cheaper globally → Exports increase.

● Foreign electronics become more expensive in Europe → Imports decrease.

● Net exports increase → AD shifts right.

Takeaways for Changes in Exchange Rates:

● Currency appreciation typically reduces net exports and slows economic growth.

● Currency depreciation typically boosts net exports and stimulates economic growth.

● Exchange rates are key to understanding global trade patterns and their effect on domestic economies.