Slide 1

Section 3: International Economics

3.2 Exchange Rates

1Exchange rates diagram labelling and terminologyQ0SDPrice of rupees in US$Market for rupeesUS$ per rupeeEquilibrium of demand and supply gives us the exchange rate.

Equilibrium , appreciation

Equilibrium , depreciationeq

Exchange rates Demand for exportsQ0SDMarket for rupeeseqD1e1q1Buying exports = buying the currency

Buying more exports = increase in demand= appreciation

Buying fewer exports = decrease in demand = depreciationD2e2q2US$ per rupee

Exchange rates Demand for importsQ0SDPrice of rupees in US$Market for rupeeseqe1q1Buying imports = selling the currency

Buying more imports = increase in supply= depreciation

Buying fewer imports = decrease in supply = depreciatione2q2S1S2

Exchange rates Relative interest ratesQ0SDMarket for rupeeseqe1q1The higher the interest rate, the more people will want to invest in the country.

Increase in local interest rate = increase in demand = appreciation

Increase in o/s interest rates = increase in supply= depreciatione2q2S1D1US$ per rupee

Exchange rates Relative inflation ratesQ0SDPrice of rupees in US$Market for rupeeseqe1q1The higher the inflation rate, the less attractive your exports are.

Increase in local inflation rate = decrease in demand = depreciation

Increase in local inflation rate = increase in supply= depreciatione2q2S1D1

Exchange rates Foreign investment in firmsQ0SDMarket for rupeeseqe1q1Foreign investment can be in the form of foreign direct investment or portfolio investment

Increase in foreign investment in local firms= increase in demand = appreciation

Decrease in foreign investment in local firms = increase in supply= depreciatione2q2S1D1US$ per rupee

Exchange rates SpeculationQ0SDPrice of rupees in US$Market for rupeeseqe1q1Investors buying and selling currencies to make profit

People think currency will appreciate= increase in demand = appreciation

People think currency will depreciate= increase in supply= depreciatione2q2S1D1