Exchange Rates

Lesson 14 – Money around the world

Exchange Rate

• The price of one nation’s currency in terms of another nation’s currency

• Fixed – prevented from rising and falling with changes in supply and demand

• Flexible – free to float with changes in the supply and demand

Factors that affect exchange rates

• Changes in preferences for foreign goods

• Relative incomes• Inflation• Interest rates• Speculation on future

values of foreign exchange

Changes in preferences

• More Americans want to buy Japanese goods – yen would be worth more dollars because demand for yen would increase and supply of US dollars would decrease

Changes in prices in different countries

• High inflation in Russia would make Russian goods more expensive than American goods. Russians would demand more US $$ to buy cheap US goods (supply more Russian rubles, demand more US $$$) dollar would be worth more

Changes in interest rates in different countries

• 10% on savings in Europe and 2% savings in US, Americans would demand more Euros and supply more $$$– Euro would be worth

more dollars

Changes in income in different countries

• Income in US increases compared to Mexico. People in the US buy more Mexican goods. More supply of US $$$ and more demand for pesos– Dollar would be worth

fewer pesos

Speculation

• People think the dollar will increase in value compared to the Euro, they will buy more $$$ (demand) and sell more Euros(supply)– Dollar would be worth

more Euros

• If the foreign exchange rate between the Australian Dollar and the Indian Rupee is 1:1.57 then 3 Indian Rupees equals how many Australian Dollars?

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• If the foreign exchange rate between the American Dollar and the Australian Dollar is 1:1.50 then 24 Australian Dollars equals how many American Dollars?

• If the foreign exchange rate between the Australian Dollar and the Hong Kong Dollar is 1:2.80 then 56 Australian Dollars equals how many Hong Kong Dollars?

• If the foreign exchange rate between the Mexican Peso and the Botswana Pula is 1:0.40 then 85 Mexican Pesos equals how many Botswana Pulas?

• 3 currencies• 1 WELCO = 2 DEVCOs• 1DEVCO = 2 LESCOs• 1 WELCO = 4 LESCOs• If a bicycle cost 25 DEVCOs, what is the price

in WELCOs? LESCOs?

Depreciating currency

• A currency depreciates when it buys less of another currency

Effects of Depreciation

• If you go to Italy on vacation and the $ is worth less, you have less money to buy local souvenirs.

• If you are an American business and you buy parts from France, your resource costs will increase

• If you are a Japanese firm and you buy solar equipment from the United States, you will buy more

Appreciating currency

• A currency appreciates when it buys more of another currency

• If you go to Japan on vacation and the $ is worth more, you have more money to buy local souvenirs.

• If you are an American business and you buy parts from Spain, your resource costs will decrease

• If you are an Israeli firm and you buy planes from the United States, you will buy less