Question

Foreign Exchange Markets

a. Define an exchange rate and Graph the foreign exchange market illustrating the dollar price of the pound - label all curves and each axis

b. Explain what the demand and supply curves in this market measure

c. Explain how the exchange rate automatically eliminates surpluses and shortages in the Foreign Exchange Market.

d. If the foreign exchange ratio for USD/British Pound = $1.35; how much will it cost for an American to buy a $50 pair of shoes imported from Britain; How much will it cost an Englishman to buy a $50 pair of shoes exported from the US to Britain?

e. Identify one factor that causes a currency to depreciate - graph the solution. Repeat for depreciation.

Answer 1

A). exchange rate the rate at which a currency(pound) is exchanged into another currency ( dollor).

B).the demand curve tells the demand quantity of foreign currency at different exchange rates .In USA exchange market ,the demand curve tells the demand quantity of pound at different exchange rate.as exchange rates rises people have to give more cash or domestic currency for same foreign currency ,so there will be lower demand ,so that why demand is negitive slope.

The supply curve tells the supply quantity of foreign currency at different exchange rate.as exchange rate increases people who have foreign currency wants to exchange it into domestic currency as they do it supply of foreign currency increases in the market .and supply curve is positive upward sloping curve

C).if any given exchange rate their is shortage of pound in exchange market.in this situation ,people start willing to pay more for foreign pound ,which increase exchange rate and by that there is contraction in demand of exchange rate and expansion of supply of exchange rate and by that gap between demand and supply decrease and shortage falls and this process keep continue till there is no shortage in the market and market reach at EQUILIBRIUM at demand =suply. Of foreign currency.

D). Cost to American to buy 50$ pair shoes, is 50$ in dollar or 37.03 pounds.

An Englishman have to spend 50/1.35=37.03, pounds to buy a imported 50$ shoes from america..