Macro18

Macro18 - Chapter 18: The international Monetary System:...

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Chapter 18: The international Monetary System: Order or Disorder? What are Exchange Rates? Exchange rate : the price, in terms of one currency, at which another currency can be bought. Appreciation: when a nation’s unit of currency can buy more units of foreign currency Depreciation : when a nation’s unit of currency can buy fewer units of foreign currency What is a depreciation to one country must be an appreciation to the other. Devaluation : a reduction in the official currency Revaluation : an increase in the official value of a currency Exchange Rate Determination in a Free Market Floating Exchange Rates : rates determined in free markets by the law of supply and demand In a free market, exchange rates are determined by supply and demand. At a rate below the equilibrium level, the number of euros demanded would exceed the number supplied and the price of a euro would be bid up. At a rate above the equilibrium level, quantity supplied would exceed quantity demanded, and the price of a euro would fall. Only at the equilibrium exchange rate is there no tendency for the exchange rate to change. Where does supply and demand come from? Why does anyone demand a euro? o International trade in goods and services. Demand for a countrys exports lead to demand for its currency o Purchases of physical assets such as factories and machinery overseas. Direct foreign investments leads to demand for a country’s currency o International trade in financial instruments such as stocks and bonds. Demand for a country’s financial assets leads to demand for its currency. The demand for a country’s currency is derived from the demands of foreigners for its export goods and services and for its assets— including financial assets, such as stocks and bonds, and real assets, such as factories and machinery. The supply of a country’s currency arises from its imports, and from foreign investment by its own citizens. Ex) if Europeans are attracted to large gains in US. Then they have to sell their euros for dollars which will shift supply curve for euros outward. Decreasing the price for each euro. Principal determinants of exchange rate movements differ a lot in the short, medium, and long runs. o
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Macro18 - Chapter 18: The international Monetary System:...

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