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Exchange Rates

Exchange Rates: Equilibrium


Exchange Rates on the Graph

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So it wouldn't be economics if we didn't go ahead and throw it on the graph, let's go ahead and see the equilibrium in the exchange rate market. So when we think about exchange rates, we're gonna have the supply and demand for a currency, right? The supply of US dollars traded for a foreign currency and the demand for those us dollars by foreigners, right? So the quantity of us dollars demanded. And we're thinking about foreigners here, the foreigners, the foreign demand for us dollars. Well guess what? We're still going to have our downward demand, our double Ds. So this downward demand, it's been pretty consistent throughout the course. And it follows through here we've got a quantity of US dollars demanded is going to have this downward demand. And why is that when the value of the U. S. Dollar is high? So there's a high US dollar value, we're gonna have less exports. Which is less demand because when the U. S. Dollar value is high it makes those U. S. Goods more expensive for a foreigner because the U. S. Dollar is more valuable. It's gonna cost them more to get us dollars and there's gonna be less demand for us goods. Okay and there's gonna be less foreign demand for U. S. Investments because of the same thing if they wanted to buy a U. S. Investment, what's gonna cost them more of their currency? So less demand here as well? The opposite when the value of the U. S. Dollar is low. Now U. S. Dollars are cheap to buy. Well there's gonna be more more exports leading to more demand for us dollars. And this is for us dollars and the same thing with demand for for for us investments now now that they can buy us dollars cheaper, they can buy these investments for cheaper. So there's gonna be more demand for us dollars to buy these cheaper investment when the when the dollar is weak in that case when there's a low value for the U. S. Dollar, Well foreigners are gonna buy up those cheap dollars to buy exports and foreign demand. Uh Excuse me U. S. Investments as well. Now that's the downward demand right? Because high US dollar value, lower demand, low us dollar value, more demand. Right? That's that opposite effect that we've learned with demand. That whenever the price goes up the demand goes down the price goes down the demand goes up, right? That's that downward demand. So if we look on our graph, guess what our demand curve is gonna look like, it's going to be the downward demand. So this is the demand curve for us dollars, right? The demand for us dollars, demand for us dollars there uh for foreign currency. And just so you know this is going to be quantity of U. S. Dollars and this is gonna be the exchange rate, let's say we're talking about um great british pounds per us dollar, great british pounds per us dollar. Okay so it's the exchange rate on that axis and we've got the quantity of U. S. Dollars on this axis down here. Okay so that's the demand for us dollars. Now let's look at the supply, the quantity of U. S. Dollars supplied in this foreign exchange market. Well a high value U. S. Dollar when dollars are worth a lot. That means we can buy more stuff from foreign countries more imports, right? So that there's gonna be more supply, right? We're supplying our dollars to buy these imports so there's more supply of dollars and there's gonna be more demand for foreign investments because we have this strong dollar we can buy these foreign investments for cheaper. So more supply of us dollars. We're gonna be exchanging these us dollars to buy these foreign investments a low U. S. Dollar. Well it's the opposite effect right? There's less supply because we we have a less less imports were not going to be buying as much stuff overseas because it's gonna be more expensive and less supply as well. For the same logic for foreign investments right? With a with a weak dollar it's gonna cost us more to buy foreign investments. So we're not gonna supply those dollars in that market anymore. So notice what we have here high value U. S. Dollar more supply, low value U. S. Dollar, low supply. Just like we're used to with supply as well. So supply is going to have this upward slope like we're used to and look at this graph doesn't it look familiar to us? It's our standard X shaped graph and guess where our equilibrium is. Our equilibrium is here right in the middle where the two lines cross. So this is the supply of us dollars and there we go. That's what we have here. So this is going to be our equilibrium exchange rate. So this is our equilibrium rate. I'll say our star right there and then our equilibrium quantity exchange. So that will be the quantity of dollars exchange right there. Okay so that's about it. Um That's our equilibrium in the market. We're going to get into how we shift these curves as well. One thing I want to note is sometimes you see a situation where the supply they actually treated as fixed and they'll have this straight upward supply in this market. Well we end up having very similar results because our focus here is on the exchange rate. So when we start shifting these curves are focuses on what's gonna happen in the exchange rate. Is it gonna go up? Is it gonna go down? Does the currency appreciate appreciate. So we end up with the same results regardless of if we have this upward supply or the straight up and down supply. So you can double check in your textbook double check with your teacher. I'm gonna use this because it's just what we're more familiar with and it will get us the same results. Um But if if you're gonna be having to draw these curves double check with your professor. If you're gonna have to draw the curves and make sure you do it their way. Okay? Um Either way, like I said, we'll end up with the same results here when we're analyzing the graph. Cool. Let's go ahead and pause and we'll move on to the next.