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| Graphing Exercise: Foreign Exchange Market United States exporters wish to be paid for their goods and services in dollars, yet the buyers in foreign countries possess their own local currencies, not dollars. Likewise, United States importers must pay in foreign currencies but possess only dollars. A market for foreign exchange allows U.S. importers - demanding the foreign currency - and foreign importers - supplying the foreign currency - to make an exchange. Exploration: What factors cause the exchange rate to change?Click here to view an interactive exercise. This will open a new browser window. Then answer the questions below. If you have clicked on the link above and cannot see the interactive exercise, you may need to install a free Java plugin for you internet browser. Click here for the plugin. Consider the market for Japanese yen shown in the graph. The price is measured in the number of U.S. dollars required to purchase one Japanese yen. Currently, the market is in equilibrium - neither surplus nor shortage. Using the interactive graph, you can illustrate the impacts of changes in exports or imports on the market for foreign exchange. 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. 1. Suppose U.S. citizens wish to import more goods from Japan. Will the yen appreciate or depreciate relative to the dollar? AnswerAn increase in desired imports will require U.S. citizens to acquire more yen: the demand for yen will increase. Drag the demand curve to the right and click on the New Equilibrium button. The excess demand for yen causes the dollar price of yen to increase - the yen appreciates (the dollar depreciates). The rising value of the yen causes U.S. goods to be cheaper (in yen terms) to the Japanese. Although the supply curve does not move, the quantity of yen supplied increases as Japanese importers purchase more of the now relatively cheaper U.S. goods. 2. Alternatively, suppose Japanese citizens wish to import more goods from the U.S. Will the yen appreciate or depreciate relative to the dollar? AnswerA desire by Japanese to acquire more U.S. goods will cause them to bring yen to the market where they may be exchanged for the dollars required by U.S. exporters. That is, the supply of yen will increase. To observe the effect on the yen market, drag the supply curve to the right and click on the New Equilibrium button. The excess supply of yen causes the dollar price of yen to fall - the yen depreciates (the dollar appreciates.) The falling value of the yen causes Japanese goods to be cheaper (in dollar terms) to U.S. citizens. Although the demand curve does not move, the quantity of yen demanded increases as U.S. citizens buy more of the now less expensive Japanese goods. |