Transcript US$ Depreciation

The Determination of
Exchange Rates
Part I.
Equilibrium Exchange Rates
I. SETTING THE EQUILIBRIUM
A. The exchange rate
is the price of one unit of foreign currency
expressed as a certain price in local
currency.
For example $.99/€ means the euro in the
U.S. is worth $.99.
Equilibrium Exchange Rates
B. How Do Americans Purchase
German Goods?
1. Foreign Currency Demand:
• derived from the demand for foreign country’s goods,
services, and financial assets.
e.g. Americans demand German
goods such as Mercedes autos
The Demand for € in the U.S.
$/€
D
$1.20/ €
$1.10/ €
$1.00/ €
Qty
At higher exchange rates, Americans demand
less euros and vice versa.
Equilibrium Exchange Rates
2. Foreign Currency Supply:
• derived from the foreign country’s demand for
Indian goods.
• Foreign buyers must convert their currency in
order to purchase.
e.g. German demand for Indian goods such
as Maruit Cars means Germans must convert
euros to Indian rupees in order to buy.
The Supply of € in the U.S.
$/ €
$1.20/€
S
$1.10/€
$1.00/€
Qty
At higher exchange rates, Germans supply
more euros and vice versa.
Equilibrium Exchange Rates
3. Equilibrium Exchange Rate
Occurs where the quantity supplied equals the
quantity demanded of a foreign currency at a
specific local price.
The $/ € Equilibrium Rate
$/ €
Equilibrium
D
S
$1.10
Qty
Equilibrium Exchange Rates
C. How Exchange Rates Change
1. Increased demand
as more foreign goods are
demanded, more of the foreign
currency is demand at each
possible exchange rate
2. The price of the foreign
currency in local currency
increases.
Equilibrium Exchange Rates
3. Home Currency Depreciation
a. Foreign currency more
valuable than the home
currency.
b. Conversely, the foreign
currency’s value has
appreciated against the
home currency.
The US$ Depreciates When
$/ €
D’
D
$1.20/ €
S
$1.10/ €
Q1
Q2
Qty
Equilibrium Exchange Rates
D. Computing a Currency
Appreciation
= (e1 - e0)/ e0
where e0 = old currency value
e1 = new currency value
Equilibrium Exchange Rates
EXAMPLE: € Appreciation
If the dollar value of the € goes from $1.10
(e0) to $1.20 (e1), then the € has appreciated
by
(1.20 - 1.10)/ 1.10 = 9.1%
Equilibrium Exchange Rates
EXAMPLE: US$ Depreciation
Use the formula
(e0 - e1)/ e1
substituting
(1.10 – 1.20)/1.20 = - 8.3%
is the US$ depreciation.
Equilibrium Exchange Rates
D. FACTORS AFFECTING
EXCHANGE RATES:
1.
Inflation rates
2.
3.
Interest rates
GNP growth rates
Sample Problem
Suppose the U.S. dollar appreciates
against the Russian ruble by 500%.
How much did the ruble depreciate
against the dollar?
Sample Problem
Depreciation of the ruble:
(e0  e1 )
x
e1
e1 e0
 5
e0 e0
Sample Problem
e1
e0

e0
e0
 5
e1
11  5 1
e0
e1  6e0
(e0  e1 )
 x
e1
e0  6e0
 x
6e0
5
 x
6
x  83%