ECON 1010 Lecture Notes - Lecture 12: Foreign Exchange Market, Canadian Dollar, Economic Equilibrium
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ECON 1010 Lecture 12
05th March 2019
Exchange Rate and Balance of Payments
Exchange rate is the price of the Canadian dollar on the foreign exchange market. It is
determined by people who go to foreign exchange who demand Canadian dollar and whom
supply Canadian dollars. That interaction of demand and supply is what determines the
foreign exchange rate.
So, we will look at how demand supply determine the price in the market and the exchange
rate (like I mentioned earlier) is the price of Canadian dollar in the foreign exchange market.
It is an equilibrium like any equilibrium in that if the price is anything other than the
equilibrium, COMPETITIVE forces will be set in motion and push towards that equilibrium
Fig 9.3 foreign exchange market for Canadian dollars
Question: This is a downward sloping demand curve, who demands Canadian dollars on
foreign exchange market and for what do they demand Canadian dollars for?
Answer: people who do not have Canadian dollars, foreigners, they want to buy Canadian
dollars or are speculators (buy low, sell high), or buy assets
Question: why is it that when the exchange rate or the price of Canadian dollars is high, the
quantity demanded of Canadian dollars is low?
Answer: Products and assets becomes more expensive for the rest of the world when they
have to convert their currency to get Canadian dollars
At Equilibrium exchange rate, quantity demanded = quantity supplied of C$
Reciprocal exchange rate:
Flipping the question. What does the U.S dollar cost in Canadian dollars
- If C$ 1.00 = U.S$0.80, reciprocal exchange rate is US$1.00 = 1/ 0.80 = C$1.25
When C$ appreciates against my currency, that currency depreciates against C$, and vice
Rememner, supply of one currency is demand for another currency.
- Americans demanding C$ Supply US$ in exchange. And vice versa for Canadians.
- FOR RECIPROCAL EXCHNAGE RATE, DIVIDE ONE BY THE OTHER EXCHANGE RATE.
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Fluctuating exchange rates
They are caused by changes in interest rate differentials. R.O.W (REST FO WORLD) demand
for Canadian exports, and expectations by speculators.
Exchange rate are unusual and unique because:
Forces or assumptions that change both the demand curve and the supply curve at the
same time. It is unusual, why?
Let us look at micro to understand above
What are assumptions behind micro demand curve, what do we hold constant?
2. Price of related goods like substitutes and complements
5. Expected Future Price
In exchange rate, what are we holding constant in that positive relationship between
quantity and supply,
1. Number of suppliers (number of firms)
2. State of nature
4. Cost of production or price of inputs
5. Expected future prices
WHAT IS IN COMMON BETWEEN THOSE TWO LISTS?
- Expected future prices
When, for example, preferences change, it shifts demand not supply. When technology
changes, it shifts supply not demand.
A lot more volatility (degree of variation) in exchange rate
Interest rate differential
Suppose interest rate goes up in one country but not in another.
- Canadian interest rate goes up and stays the same in R.O.W
- That will cause Canadian dollar to appreciate
With higher interest rates in Canada, if you invest in Canadian assets, you willing et higher
returns, so people around world will find Canadian dollars attractive so if they want to
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