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Unit 14 - Lesson 1
Learning outcomes:
Exchange Rates
A mechanism of establishing the values of one currency in relation to
another.
August 2014:
Number of Tsh per US $: $1 = 1,650 Tsh
January 2016:
Number of Tsh per US $1: $1 = 2,165 Tsh
In this unit we will look to understand what causes changes in the value of
one currency in relation to another.
Currency Graphs
Vertical Axis: Price of Dollars in terms of Euros
Horizontal Axis: Quantity of Dollars
Demand Curve represents the Demand for Dollars
Supply Curve represents the Supply of Dollars
Demand is downward sloping.
Demand for Dollars arises from:
1.
2.
Tragakes: pg. 382
3.
Currency Graph
Supply Curve for Dollars is upward sloping
Supply for Dollars arises from:
1. US residents importing goods from Europe
2. US residents taking holidays in Europe
3. US resident planning to invest in Europe
The intersection of the Supply & Demand for
Dollars represents the equilibrium free floating
exchange rate.
1. The intersection of the Supply & Demand for Dollars represents the
equilibrium free floating exchange rate.
2. If the exchange rate were set higher than the equilibrium price & quantity
there would exist excess supply in the market.
3. If the exchange rate were set lower than the equilibrium price & quantity
there would exist excess demand in the market.
Example:
There is a significant
increase in the amount of
European Tourists
visiting the USA.
Due to a change in
consumer preferences in
the Europe there is an
increase in Demand for
US products
Tourism: when European come to the USA they Supply Euros to the market
(Increase in Supply of Euros) and Demand Dollars (Increase in Demand for $).
Imports: when Europeans import US products they pay for them in dollars.
Europeans Supply Euros to the market and Demand dollars in return.
Result is an Appreciation of the US $ and a Depreciation of the Euro.
Changes in Income:
If income levels increase in Tanzania relative to other countries then
Tanzania residents will Demand more Imports.
Increase in Imports - Increase in Supply of Tsh to purchase imports Depreciation of the Tsh.
Speculation:
If Currency Traders expect a currency to appreciate this result in
increased Demand for the currency and contributes to the Appreciation of
the currency.
Vice Versa.
Summary
1. As Demand for a countrys exports increases, its currency appreciates.
2. As a countrys imports increase, its currency depreciates.
3. A countrys interest rates and the value of the currency change in the
same direction.
4. Increase in Interest Rates - Appreciation of the currency
5. Decrease in Interest Rates - Depreciation of the currency
6. Higher Inflation Rate in a country relative to another leads to currency
Depreciation.
7. An Increase in Foreign Investment from abroad results in currency
Appreciation.
8. A countrys level of Income relative to other countries causes the value of
the currency to change in opposite directions.