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Chapter 25

Economics 1022A/B Chapter Notes - Chapter 25: Foreign Exchange Market, The Foreign Exchange, Canadian Dollar


Department
Economics
Course Code
ECON 1022A/B
Professor
Jeannie Gillmore
Chapter
25

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Macroeconomics 1022B
Lecture Cycle 6
Chapter 25: The Exchange Rate and the Balance of Payments
The Foreign Exchange Market
Whenever people buy things from another country they use the currency of that country to
make the transacon.
Foreign money is just like Canadian money – It consists of notes/coins issued by a central bank
and deposits in banks and other depository instuons.
Foreign Currency - The money of other countries regardless of whether that money is in the
form on notes, coins or bank deposits.
Trading Currencies
Foreign Exchange Market – Market in which currency of one country is exchanged for the
currency of another.
-Made up of thousands of people – importers and exporters, banks, internaonal investors
and speculators etc.
Exchange Rates
Exchange Rate – Price at which one currency exchanges for another currency in the foreign
exchange market.
- Exchange rate uctuates in 2 ways:
1. Appreciaon – Rise in the exchange rate.
2. Depreciaon – Fall in the exchange rate.
An Exchange Rate is a Price
Exchange rate is a price – the price of one currency in the terms of another.
Like all prices, an exchange rate is determined in a market - the foreign exchange market.
Because it has many traders and no restricons as to who can trade, the foreign exchange
market is a compeve market.
-Supply and demand determine the price in a compeve market (exchange rate).
Demand for One Money is the Supply of Another
When people are holding the money of another country want to exchange it for Canadian
dollars, they demand Canadian dollars and supply that other countrys money. And Vice versa.
-Factors that in6uence the demand of Canadian dollars also in6uence the supply of yen,
euros, and pounds etc.
Demand in the Foreign Exchange Market
People buy Canadian dollars so they can buy Canadian produced goods/services (Canadian
exports) or so they can buy Canadian assets such as bonds, business, etc.

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The quanty of Canadian dollars demanded in the foreign exchange market is the amount that
traders plan to buy during a given me period at a given exchange rate. This quanty depends
on many factors, main ones are:
1. The exchange rate
2. World demand for Canadian exports
3. Interest rates in the US and other countries
4. The expected future exchange rate
The Law of Demand for Foreign Exchange
Other things remaining the same, the higher the exchange rate, the smaller is the quanty of
Canadian dollars demanded in the foreign exchange market.
The exchange rate inuences the quanty of Canadian dollars demanded for 2 reasons:
1. Exports E<ect – The larger the value of Canadian exports, the larger is the quanty of
Canadian dollars demanded in the foreign exchange market. But
the value of Canadian exports depends on the prices of Canadian
goods/services expressed in the currency of the foreign buyer.
-These prices depend on the exchange rate – the lower the
exchange rate, the lower are the prices of Canadian-produced
goods/services to foreigners. If exchange rate falls, quanty of
Canadian dollars demanded in the foreign exchange market
increases.
2. Expected pro=t E<ect – The larger the expected pro=t from holding
Canadian dollars, the greater is the quanty of Canadian dollars
demanded in the foreign exchange market.
-Depends on the exchange rate - the lower the exchange rate today,
the greater is the expected pro=t from holding Canadian dollars, so
the greater is the quanty of Canadian dollars demand in the
foreign exchange market.
Demand Curve for Canadian Dollars
A change in the exchange rate, other things remaining the same, brings
a change in the quanty of Canadian dollars demanded and a
movement along the demand curve.
Supply in the Foreign Exchange Market
People and business sell Canadian dollars and buy other currencies so that they can buy foreign-
produced goods/services (Canadian imports) or so that they can buy foreign assets such as
bonds, stocks etc.
The quanty of Canadian dollars supplied in the foreign exchange market is the amount that
traders plan to sell during a given me period at a given exchange rate. This quanty depends
on many factors, main ones are:
1. The exchange rate
2. Canadian demand for imports
3. Interest rate in the US and other countries
4. The expected future exchange rate
The Law of Supply of Foreign Exchange Market
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