Exchange Rates: Shifts in Supply and Demand
Exchange Rates: Shifts in Demand
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now let's see how shifts in the supply and demand curve affect the exchange rate market. And what happens to our equilibrium. So like we saw there's going to be an equilibrium in the exchange rate market right? We have our X. Graph with our exchange rate equilibrium in the middle. And then now what we're gonna do is we're gonna shift the demand or the supply to the left or the right and see where our new equilibrium exchange rate ends up. Okay so we have our supply and demand just like we're used to, let's start here with shifts in demand. So the shift in the quantity of us dollars demanded and this is foreigners demanding us dollars. So remember when we're going to shift the curve where we're shifting the demand curve, it would be because some sort of determinants, some sort of underlying factor to demand is changed from where it was before. Okay so we'll have our where our demand was and then something has changed that's going to have shifted to the left or right. The first thing could be a change in the foreign countries income. So let's say the foreigners are making more income now, well if there's more foreign income, well they're gonna want to import more stuff, they're gonna uh they're going to have more money available and they're gonna want to buy more things so there's gonna be more demand for the U. S. Dollar. Okay so more foreign income that leads to a shift to the right, if they have less foreign income if they're making less money. Well they're not gonna be able to afford us goods and they will not demand the U. S. Dollars. So we'll have the opposite if there's a change in U. S. Interest rates. Well nothing about U. S. Interest rates as investments. So if there's higher interest rates in the U. S. That means people would want to invest in us uh investments to get that higher interest, right? So when the U. S. Interest rates go up, there's more demand for us dollars to buy uh to buy us investments and get these higher interest rates. So that would shift it to the right as well. And that's when there's a change in the interest rate. The third thing is a change in speculative outlook. So when we talk about speculation, this is people just expecting things to happen, this is more almost like gambling but like gambling on what you expect to happen in the future. So they're making expectations of rate changes in the future. So if you think these speculators, people who are looking into the market and doing analysis and saying I think in the future uh the U. S. Dollar is going to appreciate in value. Well that means people are going to demand more dollars right now right? They're gonna want those dollars now so that they'll be stronger in the future, they'll hold the dollars and they'll appreciate in the future and be worth more money. So these speculators would make money on this investment here by getting the U. S. Dollars now. So we can have good things or bad things right? We discussed in these examples, all the good things that can happen that would affect demand, right, more foreign income, higher interest rates, expected appreciation. But the opposite could happen as well, right? Less income, lower interest rates and the opposite effect would happen. So just like when we talked about shifting demand in other cases, we have what's the good shifts which are shifts to the right, good for demand and then bad for demand, right things that are going to shift it to the left. So let's start here and let's do our good shift. And we'll have our original graph, we'll do our original in blue where we're gonna have our downward demand upward supply. Remember this will be, will say great british pounds to US dollars, This will be our exchange rate, the price of these U. S. Dollars in this market. And then the quantity of U. S. Dollars uh down here. Okay, so if this was our original equilibrium here and something good happened to demand, say there was higher interest rates in the U. S. Leading to higher demand for us dollars. Well, we would shift to the right, we would shift to the right and we would end up in a situation like this, right? So that was our original, our original equilibrium and now our new equilibrium. So our original equilibrium will say was rate one. And this quantity quantity one. Now, what I want to say is we generally focus on what happens to the exchange rates in these. Okay, so we want to see did the exchange rate go up or down when we when we had the shift to the right of demand. So now we're at demand to hear what we have this higher exchange rate, right? And what does that mean? That means there's more great, great british pounds per dollar. So if this was 1.5 to $1 So £1.1.. per dollar. Now we're at say £1.7 per $1. Okay, 1.7 to $1. It went up, The rate went up in that situation, right? So each dollar can get more pounds. The dollar has appreciated when the demand goes up, right, The price goes up in that sense. Cool. How about the other situation when we have a bad example here? When let's say now, um we have foreign income decrease. So there's less less exports and there's less demand for us dollars. We'll have the same thing where we start with our original situation, we've got our supply or demand and now we have a decrease in demand and we have our new equilibrium down here, Right? So where our original equilibrium here was our one. Well, now we've decreased our equilibrium, not that much. We've decreased right here to our two. So this is the opposite situation. If we had started, let me get out of the way. So if we had started here at our original equilibrium, let's say was um 1.5-1, like we said before, pounds to dollars. Well now let me do it in a different color, so it stands out. So this was a situation where we're like £1.. $1. Well now we're at say £1.3 for $1 The dollar has gotten weaker, right? We're getting less pounds per dollar. In this situation, we go to the bank with $1 and we only get £1.3 where we used to get 1.5, right? Because the demand has weakened, so the the price of those dollars has gone down. Okay, So that's kind of what we're used to except now the only thing that's different is this y axis, right? Where we're thinking about the exchange rate on that Y axis. Okay, so let's go ahead and pause here and let's talk about shifts in supply.
Exchange Rates: Shifts in Supply
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All right, So let's continue here with the shifts in the supply in the exchange rate market and notice how similar these are. Two. What we talked about above except now we're talking about say us income. So let's look at these shifts in supply, the first one being a change in U. S. Income. So before we talked about the change in foreign income demanding us dollars. Now it's the U. S. Income has increased and we're going to buy foreign goods. So we're gonna be supplying our dollars to buy foreign goods. So when there's more U. S. Income, there's more demand for imports. And when we buy things with imports, we're supplying our dollars in the market and we're buying things uh we're we're buying things from other countries. So our dollars are being supplied to the market and then we're we're buying imports here. So there's more supply of us dollars in that foreign market, foreign exchange market there. And the second notice this is the opposite as well. Now it's a change in foreign interest rates. So this again is us dollars being supplied, We're taking our dollars and we're paying to buy foreign investments. So when there's higher foreign interest rates, we wanna buy those foreign investments to get that higher interest. So we supply our U. S. Dollars and we buy those foreign interests foreign investments. So there's more supply of us dollars. And finally just like before there could be a change in the speculative outlook. So this one is the opposite as well if there's an expected depreciation of us dollars. What we would supply those dollars now, there would be more supply of us dollars now so that we could buy foreign investments and then later re buy those dollars at a cheaper price. Okay, so it's the opposite here, um when there's an expected depreciation of the US dollar, well, we have a decrease in the supply. Excuse me. And and an increase in the supply there as well. Okay, so again, we have the opposite effects too. Right? If there's a decrease in U. S. Income, right, we would see the opposite effect, a lower supply, a decrease in foreign interest rates, right? So let's go ahead. And just like before, let's see what happens on our graphs here, when we have the good thing happen to supply and the bad thing happened to supply. So we'll start with our original situation, which is just our standard X graph. Remember this will be say great british pounds to us dollars, and this will be the quantity here. So if this was our original demand and supply, and now we had something good happen to supply, say there was higher us income. So we're demanding more imports were supplying these dollars to the market? Well, the supply is gonna shift to the right, and we're going to be in this new situation. So what happens to the exchange rate here, Where the exchange rate was originally here at R 1? Well, it's decreased, right? We see a decrease in the exchange rate, so if this was say £1.. $1. Now we're at 1.3 right, decreased £1.. $1. Okay, so it decreases their when supply increases. So that's always what you want to be able to do is figure out which way the curve shifts and then analyze the new situation and notice how we're focused mainly just on the exchange rate. We're not focused here on the quantity as much. This is the big focus of this unit, is what's happening over here. Alright. And now the opposite, a bad thing happening for supply here. So this would be a situation where uh say the U. S. Interest rates um Excuse me. The foreign interest rates have gone down right? Foreign interest rates have decreased, so there's less investment, right? And that's the opposite of what we see here when foreign interest rates went up, we were supplying more dollars. Well, if foreign interest rates go down, we're gonna supply less dollars. Okay, So we have our original situation supply and demand, and now we're gonna shift the supply to the left and we'll be at supply too. So where's our new equilibrium right there where our original rate was there? And now our rate has gone up, right, our rate has gone up to our two there. So this would be the opposite situation. Maybe we started at £1.. $1 and now we're at £1.. $1. Okay, so this is very similar to what we've done before shifting graphs left and right. Now, we're just thinking of it in the exchange rate market. Okay, so just remember those determinants there that we were dealing with with foreign income with the interest rates and speculation. Alright, so that's about it here. Let's go ahead and pause and we'll move on to the next video.