Demand and Supply of Canadian Dollars

Demand and Supply of Canadian Dollars

  • Exchange Rate:

    • The price one currency exchanges for another currency.

    • Example: If C$1.00 = US$0.95, it takes 95 cents U.S. to buy 1 Canadian dollar.

  • Foreign Exchange Market:

    • A global market where currencies are bought and sold.

    • Currency Depreciation: A fall in exchange rate of one currency for another.

    • Currency Appreciation: A rise in exchange rate of one currency for another.

  • Demand for Canadian Dollars:

    • Non-Canadians demand C$ to buy Canadian exports, assets, and for speculation.

    • Law of Demand: As the exchange rate rises, the quantity demanded of C$ decreases.

    • Higher value of C$:

      • Canadian exports and assets become more expensive for the rest of the world (R.O.W.), leading to a decrease in quantity demanded of C$.

Supply of Canadian Dollars

  • Supply of Canadian Dollars:

    • Canadians supply C$ to buy foreign currency for imports and assets, or for speculation.

    • Law of Supply: As the exchange rate rises, quantity supplied of C$ increases.

    • A higher value of C$:

      • R.O.W. finds Canadian imports and assets less expensive, thus Canadians buy more, leading to an increase in quantity supplied of C$.

Equilibrium Exchange Rate

  • At equilibrium, the quantity demanded equals the quantity supplied of C$.

  • Adjustments to Equilibrium:

    • Below equilibrium exchange rate:

    • Excess demand for C$ (shortages) leads to an increase in exchange rate.

    • Above equilibrium exchange rate:

    • Excess supply for C$ (surpluses) leads to a decrease in exchange rate.

Reciprocal Exchange Rates

  • Americans demanding C$ supply US$ in exchange.

  • Canadians demanding US$ supply C$ in exchange.

  • Reciprocal Exchange Rate:

    • To find, divide 1 by the existing exchange rate.

    • Example: If C$1.00 = US$0.90, then US$1.00 = C$1.11.

  • If C$ appreciates against a currency, that currency depreciates against C$, and vice versa.

Fluctuating Exchange Rates

  • Five economic forces can change both demand and supply in the foreign exchange market:

    1. Interest Rate Differential:

    • Higher Canadian interest rates lead to C$ appreciation; lower rates lead to depreciation.

    1. Inflation Rate Differential:

    • An increase in Canadian inflation causes C$ depreciation; a decrease leads to appreciation.

    1. Economic Growth:

    • Increased imports can slightly depreciate C$.

    • Increased investor confidence causes strong appreciation of C$.

    1. World Demand for Canadian Exports:

    • Increased demand for Canadian exports causes appreciation of C$.

    1. Speculation:

    • Speculation on future value can greatly influence demand and supply dynamics.

International Transmission Mechanism

  • International Transmission Mechanism: How exchange rates impact real GDP and inflation.

    • Appreciation of C$:

    • Negative for aggregate demand.

    • Reduces net exports, leading to decreased GDP and higher unemployment.

    • Depreciation of C$:

    • Positive aggregate demand shock.

    • Increases net exports, raising GDP and lowering unemployment.

Purchasing Power Parity (PPP)

  • PPP: Exchange rates adjust so that money has equal real purchasing power in any country.

    • C$10 should buy the same products in Canada and when converted to US$ at PPP exchange rate.

International Balance of Payments

  • Balance of Payments Accounts:

    • Measures a country’s international transactions including current account and financial account.

    • Current Account: Inflows from exports, outflows from imports.

    • Financial Account: Measures international investments in financial assets.

    • Statistical Discrepancy: Error adjustments ensuring balances add to zero.

Key Concepts in Monetary Policy

  • Money: Acceptable for payment with three functions:

    1. Medium of exchange.

    2. Unit of account.

    3. Store of value.

  • Loanable Funds Market:

    • Determines interest rates through the interaction of demand (borrowers) and supply (savers).

  • Multiplier Effect:

    • Predicts the effect on equilibrium expenditure and real GDP from changes in autonomous spending.

Aggregate Demand and Supply

  • Aggregate demand based on consumption, investment, government spending, and net exports.

  • Changes in aggregate demand can occur due to expectations, interest rates, government policy, or exchange rates.

  • Aggregate supply impacted by input prices and changes in production capacity.

  • Shocks can lead to either recessionary gaps (negative demand) or inflationary gaps (positive demand).

  • Understanding the interaction between aggregate demand and supply is crucial for macroeconomic policy-making.