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Session 8 Exchange Rates

Session 8 Exchange Rates. Disclaimer: The views expressed are those of the presenters and do not necessarily reflect those of the Federal Reserve Bank of Dallas or the Federal Reserve System. TEKS.

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Session 8 Exchange Rates

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  1. Session 8Exchange Rates Disclaimer: The views expressed are those of the presenters and do not necessarily reflect those of the Federal Reserve Bank of Dallas or the Federal Reserve System.

  2. TEKS • Economics. The student understands the reasons for international trade and its importance to the United States and the global economy. The student is expected to: (C) analyze the impact of U.S. imports and exports on the United States and its trading partners. • Economics. The student understands the issues of free trade and the effects of trade barriers. The student is expected to: (C) analyze the effects of changes in exchange rates on imports and exports.

  3. Teaching the Terms • Exchange rates • Appreciate • Depreciate • Purchasing power parity • Nominalvalues • Real values

  4. Foreign Exchange Market • Derived demand • Currencies are bought and sold • Largest financial market in the world • Operates 24 hours a day

  5. Nominal Exchange Rates • Rate at which the currency of one country can be exchanged for the currency of another country • Depreciate = Weaken = Lose value • Appreciate = Strengthen = Gain value

  6. Exchange Rates • One exchange rate is the reciprocal of another exchange rate • If €1 = $2.00, then $1 = €0.50 • As the exchange rate fluctuates, the value (or strength) of each currency is affected • When one currency strengthens, the other weakens

  7. Weakening Dollar / Strengthening Euro

  8. Weakening Euro / Strengthening Dollar

  9. Exchange Rates in the Short Run • Model with supply and demand graph • Quantity of dollars • Price of a dollar in a foreign currency • Factors affecting supply of dollars • American purchase of goods and services produced abroad • American investment in foreign assets • Factors affecting demand for dollars • Foreign purchase of American goods and services • Foreign investment in American assets

  10. S1 S2 1 Number of Euros per Dollar 2 D1 Quantity of Dollars Traded 1 2

  11. S1 2 1 Number of Euros per Dollar D2 D1 1 2 Quantity of Dollars Traded

  12. A stronger U.S. dollar means …

  13. A weaker U.S. dollar means …

  14. Exchange Rates in the Long Run • Law of one price Identical items should sell for the same price • Purchasing power parity (PPP) One unit of domestic currency will buy the same basket of goods anywhere in the world • PPP implies that the real exchange rate will always be 1

  15. Exchange Rates in the Long Run • Real exchange rate Rate at which the goods and services of one country can be exchanged for the goods and services of another country • Real exchange rate = Dollar price of domestic goods Dollar price of foreign goods

  16. Questions?

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