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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.

Visit this website to learn about the Big Mac index.

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

where we get a research paper on Nano chemistry....?
Maira Reply
nanopartical of organic/inorganic / physical chemistry , pdf / thesis / review
what are the products of Nano chemistry?
Maira Reply
There are lots of products of nano chemistry... Like nano coatings.....carbon fiber.. And lots of others..
Even nanotechnology is pretty much all about chemistry... Its the chemistry on quantum or atomic level
no nanotechnology is also a part of physics and maths it requires angle formulas and some pressure regarding concepts
Preparation and Applications of Nanomaterial for Drug Delivery
Hafiz Reply
Application of nanotechnology in medicine
what is variations in raman spectra for nanomaterials
Jyoti Reply
ya I also want to know the raman spectra
I only see partial conversation and what's the question here!
Crow Reply
what about nanotechnology for water purification
RAW Reply
please someone correct me if I'm wrong but I think one can use nanoparticles, specially silver nanoparticles for water treatment.
yes that's correct
I think
Nasa has use it in the 60's, copper as water purification in the moon travel.
nanocopper obvius
what is the stm
Brian Reply
is there industrial application of fullrenes. What is the method to prepare fullrene on large scale.?
industrial application...? mmm I think on the medical side as drug carrier, but you should go deeper on your research, I may be wrong
How we are making nano material?
what is a peer
What is meant by 'nano scale'?
What is STMs full form?
scanning tunneling microscope
how nano science is used for hydrophobicity
Do u think that Graphene and Fullrene fiber can be used to make Air Plane body structure the lightest and strongest. Rafiq
what is differents between GO and RGO?
what is simplest way to understand the applications of nano robots used to detect the cancer affected cell of human body.? How this robot is carried to required site of body cell.? what will be the carrier material and how can be detected that correct delivery of drug is done Rafiq
analytical skills graphene is prepared to kill any type viruses .
Any one who tell me about Preparation and application of Nanomaterial for drug Delivery
what is Nano technology ?
Bob Reply
write examples of Nano molecule?
The nanotechnology is as new science, to scale nanometric
nanotechnology is the study, desing, synthesis, manipulation and application of materials and functional systems through control of matter at nanoscale
Is there any normative that regulates the use of silver nanoparticles?
Damian Reply
what king of growth are you checking .?
What fields keep nano created devices from performing or assimulating ? Magnetic fields ? Are do they assimilate ?
Stoney Reply
why we need to study biomolecules, molecular biology in nanotechnology?
Adin Reply
yes I'm doing my masters in nanotechnology, we are being studying all these domains as well..
what school?
biomolecules are e building blocks of every organics and inorganic materials.
Equilibrium price is a stable price and it must stay.discuss
Elvis Reply
Card 14 / 21: What are the similarities between a consumer’s budget constraint and society’s production possibilities frontier, not just graphically but analytically?
Ali Reply

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Source:  OpenStax, Principles of macroeconomics for ap® courses. OpenStax CNX. Aug 24, 2015 Download for free at http://legacy.cnx.org/content/col11864/1.2
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