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Chapter 25

Economics 1022 Chapter 25 notes

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Department
Economics
Course
Economics 1022A/B
Professor
Jeannie Gillmore
Semester
Fall

Description
Chapter 25 Foreign Exchange Market  Foreign currency: Money of other countries regardless of what form it is in (notes, coins, or bank deposits)  Exchange rate: Price at which one currency exchanges for another currency in the foreign exchange market o Appreciation (of a currency): A rise in the exchange rate o Depreciation (of a currency): A fall in the exchange rate  Foreign exchange market: The market in which the currency of one country is exchanged for that of another o Factors that influence the demand for one currency affects the supply for other foreign currencies o A competitive market with many traders and no restrictions on who can trade. o Demand and supply determine the price.  Demand in the foreign exchange market: o People buy Canadian dollars in the foreign markets to buy Canadian goods, services, and assets o The quantity of Canadian dollars demanded in the foreign exchange market is the amount that traders plan to buy during a given time period at a given exchange rate. Depend on:  Exchange rate  Other things remaining the same, the higher the exchange rate, the smaller the quantity of Canadian dollar demanded in the foreign exchange market (law of demand)  Exports effect: The lower the exchange rate, o The cheaper are Canadian goods to foreigners and the greater the level of exports o The greater the quantity of Canadian dollars demanded  Expected profit effect: The lower the exchange rate, o The greater the expected profit from buying Canadian dollar o The greater the quantity of dollars demanded on the foreign exchange market  World demand for Canadian exports  Interest rates in Canada and other countries  Expected future exchange rate o Demand curve: A change in the exchange rate (other things remaining the same) brings a change in the quantity of Canadian dollar demanded and a movement along the demand curve.  Supply in the foreign exchange market: o People sell Canadian dollars and buy other currencies to buy foreign goods, services, and assets. o Quantity of currency supplied in the foreign exchange market is the amount that traders plan to sell during a given time period at a given exchange rate. Depend on:  Exchange rate  Other things remaining the same, the higher the exchange rate, the greater is the quantity of Canadian dollar supplied in the foreign exchange market.  Imports effect: The higher the exchange rate, o The cheaper are foreign produced goods to Canadian and the greater the imports o The greater the quantity of Canadian dollars supplied  Expected profit effect: The higher the exchange rate, o The larger the expected profit from selling Canadian dollars o The greater the quantity of dollars supplied on the foreign markets.  Canadian demand for imports  Interest rates in Canada and other countries  Expected future exchange rate o Supply curve: A change in the exchange rate, other things remaining the same, brings a change in the quantity of Canadian dollars supplied and a movement along the supply curve.  Market equilibrium: o The exchange rate adjusts to make the quantity of dollars demanded equal the quantity of dollar supplied. o If the exchange rate is low, there is a shortage of dollars and the exchange rate rises. o If the exchange rate is high, there is a surplus of dollars and the exchange rate falls. Exchange Rate Fluctuations  Change in demand (curve) occurs when there is change in: o World demand for Canadian exports  Increase in the world demand for Canadian exports increases the demand for Canadian dollars  Decrease in the world demand for Canadian exports decrease the demand for Canadian dollars o Canadian interest rate relative to foreign interest rate  Canadian interest rate differential: Canadian interest rate – foreign interest rate  Higher the Canadian interest rate differential, higher the demand for Canadian dollars.  Lower the Canadian interest rate differential, lower the demand for Canadian dollar. o Expected future exchange rate  Rise in the expected future exchange rate increases the demand for Canadian dollar  Fall in the expected future exchange rate decreases the demand for Canadian dollar  Change in supply (curve) occurs when there is change in: o Canadian demand for imports  Increase in the Canadian demand for imports increase the supply of Canadian dollars  Decrease in the Canadian demand for imports decrease the supply of Canadian dollars o Canadian interest rate relative to foreign interest rate  Larger the Canadian interest rate differential, smaller the supply of Canadian dollars  Smaller the Canadian interest rate differential, larger the supply of Canadian dollars o Expected future exchange rate  Rise in the expected future exchange rate decreases the supply of Canadian dollars  Fall in the expected future exchange rate increases the supply of Canadian dollars  Change in the interest rate: o If demand for Canadian dollar rises and supply remains the same, the exchange rate increases o If demand for Canadian dollar falls and supply remains the same, the exchange
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