| Chapter 15 Outline |
| VIII. EXCHANGE RATES AND THEIR DETERMINATION |
| A. The Importance of Demand and Supply |
| 1. An exchange rate is the number of units of one currency exchangeable for one
unit of another. |
| 2. The United States now uses a system of flexible or floating exchange rates. |
| 3. Under this system, exchange rates are determined by the demand for and the supply of dollars. |
| a. The demand for dollars is based on other countries' desires to purchase
our domestic goods and services and to invest in this country. |
| b. The supply of dollars is based on U.S. citizens' desires to purchase the
goods and services from other countries. |
| c. The equilibrium exchange rate occurs where the quantity of dollars demanded equals the quantity of dollars supplied. |
| 4. If the exchange rate is not at its equilibrium level, there is a tendency for it to move towards the equilibrium rate. |
| a. If the quantity of dollars supplied exceeds the quantity of dollars
demanded, the exchange rate will fall (A depreciation of the dollar
occurs.). |
| b. If the quantity of dollars demanded exceeds the quantity of dollars supplied, the exchange rate will increase (An appreciation of the dollar
occurs.). |
| B. Exchange Rates and the International Price of Goods |
| 1. Movements in exchange rates alter the international price of goods and services. |
| a. If the dollar depreciates (the exchange rate falls), the relative price of domestic goods and services falls while the relative price of foreign goods and services increases. |
| | 1. The change in relative prices will increase U.S. exports and decrease its imports. |
| b. If the dollar appreciates (the exchange rate increases), the relative price
of domestic goods and services increases while the relative price of foreign goods and services falls. |
| | 1. The change in relative prices will decrease U.S. exports and increase its imports. |
| C. Real GDP |
| 1. One factor affecting exchange rates is real GDP. |
| a. Increases in real GDP in the United States will increase the supply of
dollars to foreign countries, causing the dollar to depreciate. |
| D. Inflation Rates |
| 1. A second factor affecting exchange rates is the inflation rate. |
| a. An increase in the U.S. inflation rate will increase the supply of dollars to foreign countries and decrease the demand for dollars in foreign countries, causing the dollar to depreciate. |
| E. Interest Rates |
| 1. A third factor affect exchange rate is the rate of interest. |
| a. An increase in U.S. interest rates will decrease the supply of dollars to foreign countries and increase the demand for dollars in foreign countries, causing the dollar to appreciate. |