Foreign Exchange Practice- Macro Topic 6.4 and 6.5

Foreign Exchange Practice- Macro Topic 6.4 and 6.5



hey how you doing econ students this is mr. Clifford welcome to ac/dc econ let's talk about foreign exchange one of the five key graphs that you absolutely need to know on the AP macro exam is the foreign exchange market this is the whole idea of exchange rates and the relative value of currencies so let's draw the foreign exchange market for dollars relative to euros on the bottom we have the quantity of dollars that can be exchanged up here we have the exchange rate which is the number of euros you get for each dollar we have a downward sloping demand and an upward sloping supply that sets the exchange rate now the trick to doing well in these questions is remembering who demands and who supplies currency who demands dollars Americans do not demand dollars like very rarely do I ever stand in line the foreign exchange saying I want dollars right i supply dollars so the other countries are the ones who demand dollars so in this case this is demand by Europeans Americans supply dollars so the supply is by Americans now if you keep that in your brain it makes these questions really easy to answer there are four shifters of the foreign exchange market they are tastes and preferences income price level and interest rates if the demand goes up four dollars then the dollar will appreciate and if the demand goes down the dollar will depreciate make sure to remember that currencies cannot appreciate to each other at the same time in other words the dollar cannot appreciate to the euro at the same time the euro appreciates the dollar one will appreciate and the other will depreciate also remember that appreciation is not necessarily a good thing and depreciation is not necessarily a bad thing for example what would happen to United States net exports if the dollar depreciates net exports would increase right if our dollar is weaker other countries will buy more of our stuff so our exports will go up and we'll buy less of their stuff so our imports will go down this would increase aggregate demand the point is that depreciation isn't a bad thing right people who sell stuff to other countries exporters the United States would love to have a depreciated dollar anyways let's go back to the shifters I'm going to give you four scenarios your job is to find out what happens to the dollar well appreciate or depreciate for this first one if Europe travel united states that will increase the demand to the dollar causing the dollar to appreciate if there's a decrease in incomes in Europe and there's a recession that'll mean that they're going to buy less of our stuff and so they need less of our dollars so the demand for dollars would decrease this would cause the dollar to depreciate if there's more inflation in the United States that means Europeans are going to buy less American stuff so the demand for dollars would decrease but at the same time the supply of dollars would also increase this is because Americans are going to buy more European stuff because they're relatively cheaper and then when I pay lower prices so they're going to supply more of their dollars to do it notice this is a double shift demand going down and supply going up but the point is no matter what the dollar is going to depreciate now the AP test might ask you to focus on one of those things either a decrease in demand or increase in supply but both of these events would actually occur if the United States has higher relative interest rates than Europe that means that Europeans are going to want to buy more American bonds and get that higher rate of return that means they need more American dollars so the demand for dollars would go up and the dollar will appreciate but at the same time Americans sometimes buy assets in Europe but now they're not going to go buy those assets anymore right they're going to want to buy American bonds because they have a higher interest rate so Americans would be supplying less of their dollars and supply for dollars would decrease again this is a double shift but the end result is appreciation of the dollar alright that's a quick review of foreign exchange make sure to check out my other videos and check out my AP macroeconomics review app for your smartphone and tablet until next time

20 thoughts on “Foreign Exchange Practice- Macro Topic 6.4 and 6.5

  1. You have a good knowledge of economics just like my trader has of good knowledge of trading forex and I have benefited so much from his trading strategies

  2. great video!
    Do you believe this graph focusing on the goods market has a higher explanatory power for exchange rates than the graph that explains exchange rate with an asset market approach?
    According to Mishikin, this one for the goods market does not explain short run volatility, which is why he uses the other one with supply of dollar assets as a vertical line.
    Would like to know your thoughts about it? Which one is better to teach?

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