exchange rates chapter 28 Flashcards
foreign exchange rate
an exchange rate that is determined by the market forces of demand and supply. it is the price of one currency in terms of another country; the price of the domestic currency in terms of a foreign currency
foreign exchange market
this market does not exist in a single location but is made up of financial institution that buy and sell foreign currency on behalf of private and business customers. large values of currency are bought and sold on any particular day.
what determines the price of the currency
it is determined by the relative strengths of the demand for and supply of the currency
why do currency traders buy the domestic currency
to purchase goods and services from the country. to invest in the country. to speculate on making profit if the value of the currency should rise in the future, financial institutions also speculate on future currency movements on their behalf
why is currency sold
it is sold to buy imports, to invest abroad and in expectation that the value of the currency will fall in the future
depreciation
a decrease in the international price of a currency caused by market forces
appreciation
an increase in the international price of a currency caused by market force
what will be caused by depreciation
such a fall will cause reduction in export prices in terms of foreign currencies and a rise in import prices in terms of the domestic currency
what will be caused by appreciation
This will make exports more expensive in terms of foreign currencies, and imports cheaper in terms of the domestic currency.
market forces
the economic factors affecting the price of, demand for, and availability of a commodity
foreign exchange rate
it is the price of one currency in terms of another country; the price of the domestic currency in terms of a foreign currency
what causes demand of a currency to be higher
it will rise if a higher value of exports is being sold.
why would more exports be sold
it will be sold if the country’s relative inflation rate has fallen, relative productivity has risen, the quality of products produced has risen or incomes abroad have increased
why may foreign want to buy more of the country
if they wish to purchase shares in the country’s firms due to the country’s economic prospects improving. they may also want to buy more of the currency in order to open accounts in the country’s banks because of higher interest rates.
hot money flows
flows of money moved around the world to take advantage of changes in interest rates and exchange rates
why may foreign firms purchase a greater value of the currency
to set up branches in the country, a growing market or to get round trade restrictions
what causes a fall in supply
if there is an increase in supply
why may domestic currency be sold to buy foreign one
purchase of imports, to undertake foreign travel, to purchase more of the country’s government bond, to set up firms abroad and in anticipation of a fall in the value of the currency or the country’s interest rate
what happens when there is a fall in value of exchange rate
it will make exports cheaper, in terms of foreign currencies, and imports more expensive, in terms of the domestic currency
what will be caused by depreciation on the domestic economy’s national income and real output
This may enable domestic firms to sell more products both at home and abroad. Some domestic consumers may now purchase home-made products rather than the now relatively more expensive imports. Some foreigners may now buy the country’s exports rather than products produced by firms in other countries.
what is the impact of a depreciation on the domestic price level
As the economy approaches full capacity, resources will become increasingly scarce and their prices will be bid up. In addition, finished imported products that are still purchased will be more expensive and some of these will count in the country’s consumer price index. Costs of production will be pushed up because the cost of imported raw materials will rise. Domestic firms may also feel less competitive pressure to keep costs and prices low.
what is the impact of depreciation on the domestic economy
If a depreciation does result in higher aggregate demand, firms producing for both the domestic economy and the external economy will be likely to take on more workers to expand their output. This may cause a decrease in cyclical unemployment.
what happens when there is a rise in exchange rate
it will make exports more expensive, in terms of foreign currencies, and imports cheaper in terms of the domestic currency
impact of appreciation on the domestic economy’s national income and real output
This is likely to result in a fall in demand for domestic products This could result in a slowdown in economic growth or possibly even a recession. With lower real output, incomes are likely to fall.
impact of an appreciation on domestic inflation
A higher exchange rate may also reduce inflationary pressure by shifting the aggregate supply curve to the right because of lower costs of imported raw materials. The price of imported finished products would also fall and there would be increased competitive pressure on domestic firms to restrict price rises in order to try to maintain their sales at home and abroad. appreciation can reduce inflationary pressure if the economy is operating close to or at maximum capacity because a rise in exchange rate may reduce the growth of AD
impact of appreciation on unemployment
appreciation may increase unemployment, if AD decreases, firms may not replace workers who retire and may make some workers redundant
