Question

. On June 23, 2016, 51.9% of British voters decided to leave the European Union. The media quickly dubbed this “Brexit”.   Using supply and demand graphs for both the market for pounds in the United States and the market for dollars in Britain, please show and explain how Brexit has caused the pound to depreciate.

Answer 1

(a) US: Market for pound

Brexit will lead to a fall in global investor confidence in Britain which will increase investor confidence in US assets. So global investors, will increase investment in US and this will increase demand for US dollar since investors will buy dollar by selling pounds. So supply of pound in US will rise. Supply curve of pound will shift rightward, decreasing price of pound (depreciating pound and appreciating dollar).

In following graph, P (price of pound, or dollar/pound exchange rate) and Q (quantity of pound) are measured along vertical and horizontal axes respectively. D0 and S0 are initial demand and supply curves for pounds, intersecting at point A with initial exchange rate P0 and initial quantity of pounds Q0. As supply of pound rises, S0 shifts right to S1, intersecting D0 at point B and lower (dollar/pound) exchange rate P1 (depreciating pound) and lower quantity of pounds Q1.

(b) Britain: Market for dollar

In Britain, higher demand for US dollar will cause a rightward shift in demand curve of dollar, increasing the price of dollar (appreciating dollar and depreciating pound).

In following graph, P( price of dollar or pound/dollar exchange rate) and Q (quantity of dollar) are measured along vertical and horizontal axes respectively. D0 and S0 are initial demand and supply curves for dollars, intersecting at point A with initial exchange rate P0 and initial quantity of dollars Q0. As demand of dollar rises, D0 shifts right to D1, intersecting S0 at point B and higher (pound/dollar) exchange rate P1 (appreciating dollar and depreciating pound) and lower quantity of pounds Q1.