Economics 7: Foreign Exchange
Foreign exchange market: the exchange of one currency for another takes place in this market
Decentralized market: many different locations
Exchange rate: the price of one currency in terms of another “The price of money”
The price of $1 is NAF 1.80 in SXM currency
Money is a commodity (like mangoes) to be bought and sold.
If money scarce: price goes up
If money plentiful: price decreases
Example: The price of $1 in Euros is 1.2Euro.
In NL where the currency is euros, the dollars are scarce, thus the price raised
Reciprocal exchange rate: exchange rate in the opposite direction
Reasons for buying foreign exchange/currency:
Travel & tourism
Trade: buy foreign goods
Investment: financial or real (changes in components affects market)
Example: Grenada ECD$ foreign exchange USD$
If SXMER wants to build a factory in Jamaica, we have to use USD$ to buy Jam$ or if travel
because USD$ is part of the demand market for JAM$
If study: Ackee cure COVID Demand increased, shifting curve out
Demand increased appreciation of JAM$
New equilibrium new price of JAM$ (happens every day with floating exchange rate
currencies NOT NAF)
If 1 currency becomes more valuable, then others depreciate
, When buying from foreign countries people concerned with how much domestic currency is
given up to acquire commodities: The domestic price of foreign goods:
DOMESTIC CURRENCY VALUE = FOREIGN CURRENCY PRICE X EXCHANGE RATE
US$ VALUE = PRICE IN MEXICAN PESOS X # OF MEXICAN PESOS
= 120 PESOS X 0.10 PESOS = $12
Appreciation of currency: the value rises relative to a foreign currency
Appreciated Domestic currency can buy more of foreign currency
Foreign goods become cheaper compared to the domestic currency
Domestic goods become more expensive to foreign currency (Reciprocal
exchange rate)
Thus ceteris paribus: an appreciation of domestic currency results in an
increase in imports, decrease in exports, and decrease in level of net exports
Depreciation of currency: the value declines relative to a foreign currency
Causes an increase in imported goods in domestic economy
Exports become cheaper compared to foreign markets
Thus, depreciation of a domestic currency results in a decrease in imports,
increase in exports and increase in net exports
Foreign governments control foreign exchange to manipulate currency value
Types of foreign exchange: (ER: Exchange Rate)
Fixed ER: Don’t fluctuate depending on supply & demand (Central bank sets this NAF
fixed) (Certainty)
Floating ER: currency fluctuates depending on supply & demand (must check price
constantly) (S&D determines price)
Managed ER: floating within parameters (Not fixed or floating). Central bank monitors ER:
if too low/high they intervene, supply & demand
ER value decreases: country buys own currency and make it scarce (their central bank)
If US$ depreciates mean that there is a lot of US$ in international markets.
Central bank buy a lot of US$, taking it off the market, making it scarce
Example: country controls the price of milk. If price too low farmers cant
profit, government buys milk and takes it off the market, then price
increases for consumers
Foreign exchange market: the exchange of one currency for another takes place in this market
Decentralized market: many different locations
Exchange rate: the price of one currency in terms of another “The price of money”
The price of $1 is NAF 1.80 in SXM currency
Money is a commodity (like mangoes) to be bought and sold.
If money scarce: price goes up
If money plentiful: price decreases
Example: The price of $1 in Euros is 1.2Euro.
In NL where the currency is euros, the dollars are scarce, thus the price raised
Reciprocal exchange rate: exchange rate in the opposite direction
Reasons for buying foreign exchange/currency:
Travel & tourism
Trade: buy foreign goods
Investment: financial or real (changes in components affects market)
Example: Grenada ECD$ foreign exchange USD$
If SXMER wants to build a factory in Jamaica, we have to use USD$ to buy Jam$ or if travel
because USD$ is part of the demand market for JAM$
If study: Ackee cure COVID Demand increased, shifting curve out
Demand increased appreciation of JAM$
New equilibrium new price of JAM$ (happens every day with floating exchange rate
currencies NOT NAF)
If 1 currency becomes more valuable, then others depreciate
, When buying from foreign countries people concerned with how much domestic currency is
given up to acquire commodities: The domestic price of foreign goods:
DOMESTIC CURRENCY VALUE = FOREIGN CURRENCY PRICE X EXCHANGE RATE
US$ VALUE = PRICE IN MEXICAN PESOS X # OF MEXICAN PESOS
= 120 PESOS X 0.10 PESOS = $12
Appreciation of currency: the value rises relative to a foreign currency
Appreciated Domestic currency can buy more of foreign currency
Foreign goods become cheaper compared to the domestic currency
Domestic goods become more expensive to foreign currency (Reciprocal
exchange rate)
Thus ceteris paribus: an appreciation of domestic currency results in an
increase in imports, decrease in exports, and decrease in level of net exports
Depreciation of currency: the value declines relative to a foreign currency
Causes an increase in imported goods in domestic economy
Exports become cheaper compared to foreign markets
Thus, depreciation of a domestic currency results in a decrease in imports,
increase in exports and increase in net exports
Foreign governments control foreign exchange to manipulate currency value
Types of foreign exchange: (ER: Exchange Rate)
Fixed ER: Don’t fluctuate depending on supply & demand (Central bank sets this NAF
fixed) (Certainty)
Floating ER: currency fluctuates depending on supply & demand (must check price
constantly) (S&D determines price)
Managed ER: floating within parameters (Not fixed or floating). Central bank monitors ER:
if too low/high they intervene, supply & demand
ER value decreases: country buys own currency and make it scarce (their central bank)
If US$ depreciates mean that there is a lot of US$ in international markets.
Central bank buy a lot of US$, taking it off the market, making it scarce
Example: country controls the price of milk. If price too low farmers cant
profit, government buys milk and takes it off the market, then price
increases for consumers
