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Exchange rate market for u.s. dollars reacts to higher interest rates

The graph shows how supply and demand would change if the U.S. dollar brought a higher rate of return.
A higher rate of return for U.S. dollars makes holding dollars more attractive. Thus, the demand for dollars in the foreign exchange market shifts to the right, from D 0 to D 1 , while the supply of dollars shifts to the left, from S 0 to S 1 . The new equilibrium (E 1 ) has a stronger exchange rate than the original equilibrium (E 0 ), but in this example, the equilibrium quantity traded does not change.

Relative inflation

If a country experiences a relatively high inflation rate compared with other economies, then the buying power of its currency is eroding, which will tend to discourage anyone from wanting to acquire or to hold the currency. [link] shows an example based on an actual episode concerning the Mexican peso. In 1986–87, Mexico experienced an inflation rate of over 200%. Not surprisingly, as inflation dramatically decreased the purchasing power of the peso in Mexico, the exchange rate value of the peso declined as well. As shown in [link] , demand for the peso on foreign exchange markets decreased from D 0 to D 1 , while supply of the peso increased from S 0 to S 1 . The equilibrium exchange rate fell from $2.50 per peso at the original equilibrium (E 0 ) to $0.50 per peso at the new equilibrium (E 1 ). In this example, the quantity of pesos traded on foreign exchange markets remained the same, even as the exchange rate shifted.

Exchange rate markets react to higher inflation

The graph shows how supply and demand would change if the pesos experienced inflation.
If a currency is experiencing relatively high inflation, then its buying power is decreasing and international investors will be less eager to hold it. Thus, a rise in inflation in the Mexican peso would lead demand to shift from D 0 to D 1 , and supply to increase from S 0 to S 1 . Both movements in demand and supply would cause the currency to depreciate. The effect on the quantity traded is drawn here as a decrease, but in truth it could be an increase or no change, depending on the actual movements of demand and supply.

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Purchasing power parity

Over the long term, exchange rates must bear some relationship to the buying power of the currency in terms of goods that are internationally traded. If at a certain exchange rate it was much cheaper to buy internationally traded goods—such as oil, steel, computers, and cars—in one country than in another country, businesses would start buying in the cheap country, selling in other countries, and pocketing the profits.

For example, if a U.S. dollar is worth $1.60 in Canadian currency, then a car that sells for $20,000 in the United States should sell for $32,000 in Canada. If the price of cars in Canada was much lower than $32,000, then at least some U.S. car-buyers would convert their U.S. dollars to Canadian dollars and buy their cars in Canada. If the price of cars was much higher than $32,000 in this example, then at least some Canadian buyers would convert their Canadian dollars to U.S. dollars and go to the United States to purchase their cars. This is known as arbitrage    , the process of buying and selling goods or currencies across international borders at a profit. It may occur slowly, but over time, it will force prices and exchange rates to align so that the price of internationally traded goods is similar in all countries.

Questions & Answers

What is the role of price system in The market economy
Cyrielle Reply
(1).Income is the main determined of macro economics. (a). true (b). false
Manisha Reply
yes
Anjali
tell me correct ans with examples!!
Manisha
yes
The
what yes yes?
Manisha
mam actually I want to say that income is not the main determinant of macro economics.
The
based on your knowledge about the production possibility frontier,demonstrate an assumption of supposed schedule of ppe for the production of rice and face masks by Bangladesh.use graphical representation as well
Ashraf Reply
hay
Ashraf
hlo
Karan
can you answer this
Ashraf
whats tradeoff
JUSTIN Reply
tradeoff is a balance achieved between two desirable but conflicting things
Faith
can I read in Hindi?
Rashmi Reply
don't know..
Azka
why not
Omid
Omid Amini....how?
Rashmi
sure thing
Faith
mention two necessities of estimation of national income in india ?
Krishna Reply
what means the supply
Abdourahamane Reply
hello
mosisa
hii
SHWETA
hi
Aleem
its means amount of product available right now.
Aleem
is everything important here🙂
Alizy
I mean anything*
Alizy
u can read it
Aleem
it's mean something needed or wanted
Alizy
where are from shweta
Aleem
where are you from shweta
Aleem
Hello
Anas
it may mean the stock available
DR
to make something needed or wanted available to someone
Faith
is someone who manufactures something
Faith
What is the cost-benefit analysis?
Hannah Reply
A cost benefit analysis is a process by which organizations can analyze decisions, systems or projects, or determine a value for intangibles. The model is built by identifying the benefits of an action as well as the associated costs and subtracting the costs from benefits.
sanga
thanks!
Hannah
Cost benefit analysis is a process used primarily by businesses that weighs the sum of the benefits, such as financial gain, of an action against the negatives, or costs, of that action.
ALIM
process of cost benefit analysis and decision making crieteria
Santosh
hello everyone
BtsARMY
hello every one,
Dereje
hello everyone
waqar
what is the opportunity cost?
SHWETA
The next best option forgone is call the Opportunity cost of selection one.
Oshadi
who is producer?
rishabh Reply
karan johar
Mohd
shut up mr.mohd
rishabh
it's serious question..
rishabh
shut up mr.mohd
rishabh
simple who produce good
Alizy
who is aconsumer?
Ritik Reply
who uses the commodity
Kanza
a consumer is one that buys good for consumption .
rishabh
Kanza consumers uses the commodity..
rishabh
why do we put tariff on import goods
Salam Reply
Maybe to give national enterprises better opportunities than foreign ones... or just to get more money to the national budget in any way possible. I suppose it allows also to control import and therefore its influence on national economy and other countries economy too.
Pawe
i think to control import or for development of his own industry
RAJPOOTCHANAL
what were the events during the great depression that made classical economy tenets ineffective
Alby Reply
please what is the answer for the following question; derive the expression for a two sector Keynesian model from sowotuom land economy and state all the two components in the expression.
Alby Reply
No idea
ahmad
meaning nature and scope of macroeconomics
Diksha Reply
meaning of macroeconomics
Diksha
meaning of macroeconomics
Diksha
meaning of macroeconomics
Diksha
Macroeconomics covers aggregate or in simple words overall economy of country or world while microeconomics was just concerned with individual economies
Hamza
Hope this helped you, you can search it more on Google there is a YouTube page by the name of jacob Clifford
Hamza
How aggregate demand and output gap are related explain in the light of keynesian cross diagram
Muhammad Reply

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Source:  OpenStax, Macroeconomics. OpenStax CNX. Jun 16, 2014 Download for free at http://legacy.cnx.org/content/col11626/1.10
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