Module 12 Exchange Rates

Module Overview

  • Module Title: International Economics

  • Course Title: Econ B252: Fundamentals of Economics for Business II

Module Outline

  1. Exchange Rates

    • Derived Demand (and Supply)

    • Exchange Rate Market: Changes in Supply and Demand

    • Changes in Exchange Rates

Learning Objective 4

  • Definition: Exchange Rate Market

    • Construct and identify the unique characteristics of exchange rates.

Exchange Rates, Derived Demand (and Supply)

  • Foreign Exchange Market

    • Market for buying and selling foreign currencies.

    • Market Size: Over $5 – $8 Trillion Traded Daily.

    • For comparison: New York Stock Exchange trades approximately $19 Billion Daily.

Exchange Rates Explained

  • Definition of Exchange Rates:

    • Price or Value of a currency expressed in terms of another currency.

    • Specifically, it represents one currency in terms of another.

  • Example:

    • Current Exchange Rate (as of presentation): 1 United States Dollar (USD) = 136.97 Japanese Yen (JPY).

    • Conversely, 1 Japanese Yen = 0.0073 United States Dollars (i.e., $1/136.97 = $0.0073).

Value Changes: Appreciation and Depreciation

  • Appreciation:

    • Definition: An increase in the value of a currency in terms of another currency.

  • Depreciation:

    • Definition: A decrease in the value of a currency in terms of another currency.

  • Illustrative Comparison:

    • April 2023: 1 USD = 134 Yen

    • April 2024: 1 USD = 155 Yen

    • This demonstrates a depreciation of the Yen against the USD between these dates.

Demand for Currency

  • Graphically Represented:

    • X-Axis: Quantity of Currency

    • Y-Axis: Price of Currency

  • Demand Mechanism:

    • Currency buyers generate demand, creating a downward sloping demand curve.

    • Main Purpose of Currency: To obtain goods and services.

Demand and Supply Example for Yen

  • Demand for Yen Scenarios: U.S. Derived Demand for Yen (buying Japanese laptops):

    • Various price points illustrate how many laptops would be demanded at different dollar prices.

  • Graphical Data Points:

    • At $0.015 per Yen, the price of a laptop is $1,500; 100 laptops demanded results in 10,000,000 Yen needed to buy.

    • Calculational Formula:

    • $Q = 1,100 - rac{2}{3} * P_{USD}$

    • If $P_{USD} = 1,500$, then $Q = 100$.

Yen Supply Dynamics

  • Example Calculation on Supply:

    • Suppose at $0.015 per Yen, you need actual USD to purchase 100 laptops (costing 10,000,000 Yen), this translates to USD supplied via:

    • USD Supplied = $0.015 * 10,000,000 = $150,000.

    • Further exemplified by how supply dynamics change with lower Yen values leading to more laptops sold (like at $0.003 per Yen).

Implications of Currency Value

  • Cheaper Currency Dynamics:

    • A cheaper currency increases demand to buy from that country.

    • This positively affects exports while negatively affecting imports, increasing net exports overall.

  • Currency Appreciation Implications:

    • If the home currency appreciates, foreign goods and services become cheaper, leading to increased imports and potentially decreased exports, thereby affecting net exports negatively.

Learning Objective 5

  • Determinants of Demand and Supply for Foreign Currency:

    • Analyzing how changes in supply/demand affect equilibrium for exchange rates.

  • Demand Shifters:

    • Higher Real Interest Rates = Increased Demand.

    • Enhanced Economic Stability = Increased Demand.

    • Increased Productivity = Increased Demand.

    • Higher Inflation = Decreased Demand (international customers may turn elsewhere).

  • Supply Shifters:

    • Other currency demand.

    • Influences from banks.

Case Study: Yen Exchange Rates

  • Historical Example:

    • At the beginning of 2022, 1 USD was worth roughly ¥115, increasing to ¥130 by 2023, indicating a weakening of the yen.

Analyzing Supply and Demand Changes in Exchange Rates

  • Illustrated in various graphs showing equilibrium price shifts with fluctuations in demand/supply for Yen or USD.

  • Inclusive of diagrams displaying price fluctuations across different equilibrium states.

Further Analysis of Exchange Rates

  • The Effect of Interest Rates:

    • Higher interest rates lead to:

    • Reduced money supply, rising demand and further driving up price values.

    • Impacts on the USD value correlated with fluctuations in net exports.

  • Exchange Rate Scenario:

    • If CAD moves from $0.90 to $0.95 against the USD, the analysis of what turns to the value of the USD and implications for U.S. net exports follows.