Graphing Exercise: Flexible Exchange Rates

International trade in goods and services requires the exchange of currencies as well. The exchange rate, which measures the dollar price of one unit of a foreign currency, links all Canadian prices with the prices in the foreign country, allowing citizens of both countries to determine the relative prices of goods and services. Under a system of flexible exchange rates, market forces determine the price of one currency relative to the other. An increase in demand for the foreign currency will cause its price to rise (the dollar depreciates) while an increase in the supply of the foreign currency will cause its price to fall (the dollar appreciates).

The market for Japanese yen is shown in the graph. The price is measured in the number of US dollars required to purchase one Japanese yen. Use the interactive graphs to predict the movement in exchange rates caused by changes in the determinants of supply and demand. Click on the label of the appropriate curve and drag it to a new location to shift either demand or supply; click on the New Equilibrium to observe the market adjustments necessary to restore equilibrium. Click Restore to begin a new question.

1		Suppose Japan enters a recession. What will happen to the dollar price of a yen?
2		Suppose there is a large influx of Japanese tourists into the US. What will happen to the dollar price of a yen?
3		How will the exchange rate be affected if the US experiences a severe inflation while Japan's prices remain stable?
4		Fearing a recession, American authorities lower US interest rates. How will this affect the price of a yen?
5		Currency speculators anticipate that American authorities will likely lower interest rates in the future. What will happen to the dollar price of a yen?