|Section 1: Foreign Currency Exchange Rates|
|Macroeconomics - Unit 10|
Purchasing Foreign Currency
The values of most currencies fluctuate on a daily basis. For example, a U.S. dollar may exchange for 131 Nigerian Naira today, while tomorrow it could exchange for 135 Naira. For a currency converter, please click here.
How Do Fluctuations in Exchange Rates Affect Imports and Exports?
Fluctuating exchange rates affect what an importing business pays for the foreign product. For instance, if the value of the Nigerian Naira relative to the U.S. dollar falls, then Nigerian products purchased by American businesses become less expensive. The following example illustrates this.
Let's say that this month an American oil importing company purchases 100 barrels of Nigerian oil. The following amounts are given (hypothetical data):
If next month the U.S. exchange rate becomes 135 Naira per dollar, the following happens:
The above shows that if the U.S. dollar increases in value (we receive more of their currency per dollar), then the price we pay for the foreign product decreases. If the U.S. dollar decreases in value, then the price we pay for foreign products increases.
The following is an example of a foreign country purchasing a product from the U.S.
Let's say that this month a Japanese software-importing company purchases 500 DVDs from an American company. The following amounts are given:
If next month the U.S. exchange rate becomes 125 yen per dollar, the following happens:
The above shows that if the U.S. dollar increases in value (we receive more of their currency per dollar; they receive fewer of our currency per yen), then the price that foreign countries pay for a U.S. product increases. If the U.S. dollar decreases in value, then the price a foreign country pays for U.S. products decreases.
China's exchange rate policies have come into the news lately because its government has been accused of manipulating its value. The Chinese government has kept its currency, the yuan renminbi, artificially low in order to make its exports less expensive. As the above example illustrates, if a country's currency decreases in value, its products become less expensive to foreign countries. The United States and other countries have complained to the Chinese government and asked it to allow the yuan renminbi to fluctuate according to free market forces.
Exchange Rate Determinants
Exchange rates in free (flexible) markets fluctuate with changes in supply and demand for the currency. The main determinants of demand for and supply of a currency are a country's economic and political stability, its inflation rate, its real return on investments, and speculators' expectations of the future value of the currencies. For example, if a country experiences a low rate of inflation and economic stability, then foreign countries will be more likely to invest in that country and purchase their products. This increases the demand for the country's currency and raises the value of its currency. A higher real return on investments also increases demand for a currency, as investors will purchase more of the country's stocks and bonds (or other investments) due to the higher rate of return.
An Increase in the Demand for a Currency
An increase in the demand for a currency will increase its value, and vice versa. The graph below illustrates an increase in the demand for dollars relative to the Euro. This leads to an increase in the value of the dollar relative to the Euro. The equilibrium value of the dollar increases from .80 Euros per dollar to .90 Euros per dollar.
An increase in supply of the currency will decrease the value of the currency, and vice versa. The graph below illustrates an increase in the supply of dollars relative to the Euro. This lowers the value of the dollar relative to the Euro. The equilibrium value of the dollar decreases from .90 Euros per dollar to .80 Euros per dollar.
|Last Updated on Saturday, 29 December 2012 09:01|