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By the end of this section you will be able to:

  • Explain how exchange rate shifting influences aggregate demand and supply
  • Explain how loans and banks can also be influenced by shifting exchange rates

A central bank    will be concerned about the exchange rate for multiple reasons: (1) Movements in the exchange rate will affect the quantity of aggregate demand in an economy; (2) frequent substantial fluctuations in the exchange rate can disrupt international trade and cause problems in a nation’s banking system–this may contribute to an unsustainable balance of trade and large inflows of international financial capital, which can set the economy up for a deep recession if international investors decide to move their money to another country. Let’s discuss these scenarios in turn.

Exchange rates, aggregate demand, and aggregate supply

Foreign trade in goods and services typically involves incurring the costs of production in one currency while receiving revenues from sales in another currency. As a result, movements in exchange rates can have a powerful effect on incentives to export and import, and thus on aggregate demand in the economy as a whole.

For example, in 1999, when the euro first became a currency, its value measured in U.S. currency was $1.06/euro. By the end of 2013, the euro had risen (and the U.S. dollar had correspondingly weakened) to $1.37/euro. Consider the situation of a French firm that each year incurs €10 million in costs, and sells its products in the United States for $10 million. In 1999, when this firm converted $10 million back to euros at the exchange rate of $1.06/euro (that is, $10 million × [€1/$1.06]), it received €9.4 million, and suffered a loss. In 2013, when this same firm converted $10 million back to euros at the exchange rate of $1.37/euro (that is, $10 million × [€1 euro/$1.37]), it received approximately €7.3 million and an even larger loss. This example shows how a stronger euro discourages exports by the French firm, because it makes the costs of production in the domestic currency higher relative to the sales revenues earned in another country. From the point of view of the U.S. economy, the example also shows how a weaker U.S. dollar encourages exports    .

Since an increase in exports results in more dollars flowing into the economy, and an increase in imports means more dollars are flowing out, it is easy to conclude that exports are “good” for the economy and imports are “bad,” but this overlooks the role of exchange rates. If an American consumer buys a Japanese car for $20,000 instead of an American car for $30,000, it may be tempting to argue that the American economy has lost out. However, the Japanese company will have to convert those dollars to yen to pay its workers and operate its factories. Whoever buys those dollars will have to use them to purchase American goods and services, so the money comes right back into the American economy. At the same time, the consumer saves money by buying a less expensive import, and can use the extra money for other purposes.

Questions & Answers

principle of effective demand?
Abubakar Reply
the is the situation in which the need of individuals exceed the available resource. increase in population rate and wrong decision making
esther Reply
what is the different between wants and demand?
wants are what people desire to have but they can live without them and demand is a thing that is most wanted
what are the demand pull inflation
the higher the aggregate level of activity, the larger the proportion of areas and industries which experience excess demand for goods and labour of various sorts , and the more powerful is demand-inflationary pressure . Demand inflation is contrasted with cost inflation , in which price and wage
increases are transmitted from one sector to another. These should be regarded as different aspects of an overal inflation starts , cost inflation explains why inflation once begun is so difficult to stop.
what is the important difference between positive and normative economics
positive economics is the study of how an economy works in practice, as opposed to the theoretical study of how it should run in theory and normative economics is the party of economics that is concerned with how the economy ought to be run.
positive economic deal with fact and also talks about how the economy actually is like while normative economic deal with value judgement and talks about how the economy ought to be like
What is the difference between opportunity cost and choice
opportunity cost are also known as forgun alternative why choice is to select one among alternative
importance of economic
Zakaria Reply
satisfaction of human wants
economics is about to economise . discuss
Angel Reply
Underlines the efficiency aspect. Economise towards what: Economise factors to reach equal distribution of Material wealth or Just to operate optimally to Service demand, i. e. Run markets efficiently?
join the conversation
abba Reply
what is terms of trade
Ibrahim Reply
different btn import and export
No question... This is nice
Gbenga Reply
hw can we solve problem of scarcity
scarcity is not necessarily a problem but a constant condition of the world. there are not enough resources to satisfy the unlimited wants.
wee need to be cooperative
by unlimited resourses and abundant want
why do compute GDP?
steven Reply
can anyone shortly determine the word inflation.
Ibrahim Reply
Continous increase in the general level of prices or in the cost of living.
persistent increased in general price level
all correct...
rise in price.
deserving of money
the father of economics
Reuben Reply
Adem smith
Adem smith
Adem smith sure
the father of economic regarding to adam Smith
the father of political of economic and capitalism in his book and inquary in to the wealth of the nation.
Adam Smith his the father of economic
difference between injection and leakage
what is monopoly
Monopoly is a market structure where there is one firm who dominate the industry
hi,, I am new here. please welcome me.
you are welcome
monopoly is the one characterized by a mkt power in which a firm is a price maker
Some member just ask questions but not answering so y this happen
Monopoly is a market where only one seller exists. No competition
how long does the patent right prevail the monopoly
no attempt
what is state farming
anybody to attempt
different types of price elasticity of demand with the aid of graphs
Tshepo Reply
what about mean median and mode
Dike Reply
mode is the most occurred number and median is the middle digit
the mean is the sum of all the data divided by the number eg: 2+4+4+5+3+5+1 =24÷7
what is exchange rate
thanks guys
What is Equilibrium?
that when supply equals demand. that's where the supply curve and the demand curve intercept.
equilibrium is when the both side of the price is balanced
Thanks Asuquo Agwuu
what is paradox Of drift
doris Reply
it's thrift not drift
so what is it sir
what are the causes of unemployment
Afful Reply
lack of job in the rural areas
High level of illiteracy
Unfulfilled government promises
this one no be problem waii
low rate of industrialisation
elements of economic
Muhammad Reply
Supply demand consumer and money.

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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