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Chapter 19 part 2 - IV Flexible Exchange Rates A Freely...

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IV. Flexible Exchange Rates A. Freely floating exchange rates are determined by the forces of demand and supply. Figure 36.1 (Key Graph) illustrates the exchange rate (price) for British pounds in American dollars. 1. The demand for any currency is downsloping because as the currency becomes less expensive, people will be able to buy more of that nation’s goods and, therefore, want larger quantities of the currency. 2. The supply of any currency is upsloping because as its price rises, holders of that currency can obtain other currencies more cheaply and will want to buy more imported goods and, therefore, will give up more of their currency to obtain other currencies. 3. As with other commodities, the intersection of the supply and demand curves for a currency (pounds in Figure 36.1) will determine the price or exchange rate. In the example it is $2 to 1 pound. B. Depreciation means the value of a currency has fallen; it takes more units of that country’s currency to buy another country’s currency. $3 for 1 pound would be a depreciation of the dollar, compared to the original example of $2 per pound.
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