15 Exchange Rates

Question 1

Define exchange rates

Answer 1

The price of one currency in terms of another

Question 2

How exchange rates are determined in floating exchange rate systems

Answer 2

Floating exchange rate is a system in which the exchange rate is permitted to find its own level in the market

To solve a current account deficit ( implies the trade balance is negative - the key determining factor of c/a position). This means imports exceed exports.

As a result (album) supply shifts outwards because There is more supply for the pound (for example) than there is demand for the pound.
P falls to p1, reducing the exchange rate of the pound. Here observable is a depreciation in the currency.

Widec

Question 3

.. widec occurs..

Answer 3

Weak exchange rates mean imports become dearer, exports become cheaper.

Theory: automatic stabilisation from:

• more expensive imports reduces demand, expenditure for imports. Good for ca position
• exports are cheaper: demand, revenues from exports rise (good for ca position).

However in reality other determining factors of the ca position override this (speculation)