5/8/17: Mechanics of Foreign Exchange

• Foreign Exchange-
• The buying & selling of currency.
• Any transaction that occurs in the Balance of Payments necessitates foreign exchange.
• The exchange rate (e) is determined by the foreign currency markets.
• Ex) Current exchange rate is approx. 8 yuan to 1 dollar.
• Simply put, the exchange rate is the price of a currency. 
• Changes in Exchange Rate-
• Exchange rates (e) are a function of the supply & demand for currency.
• An increase in the supply of a currency will decrease the exchange rate of a currency.
• Decrease in demand of currency will decrease exchange rate of a currency.
• Increase in demand of currency will increase exchange rate of a currency.
• Decrease in supply of a currency will increase the exchange rate of a currency.

• Appreciation & Depreciation-
• Appreciation: When the exchange rate increases.
• Depreciation: When the exchange rate decreases.
• Ex) Changing euros to dollars will increase demand for dollars, causing dollars to appreciate & euros to depreciate.

• Exchange Rate Determinants-
• Consumer Taste
• Relative Income
• Relative Price Level
• Speculation