As you already know, the key framework for analyzing prices is the operation of supply and demand in markets. Usually, the supply of and demand for foreign exchange in the domestic foreign exchange market determine the external value of the domestic currency, or in other words, a country’s exchange rate.
Individuals, institutions and governments participate in the foreign exchange market for a number of reasons. On the demand side, people desire foreign currency to:
purchase goods and services from another country
The participants on the supply side operate for similar reasons. Thus, the supply of foreign currency to the home country results from purchases of home exports, unilateral transfers to home country, investment income payments, foreign direct investments and portfolio investments, placement of bank deposits and speculation.
We shall now look into how the foreign exchange markets work. Similar to any standard market, the exchange market also faces a downward-sloping demand curve and an upward-sloping supply curve.
Figure 4.4.1
- for unilateral transfers such as gifts, awards, grants, donations or endowments
- to make investment income payments abroad
- to purchase financial assets, stocks or bonds abroad
- to open a foreign bank account
- to acquire direct ownership of real capital, and
- for speculation and hedging activities related to risk-taking or risk-avoidance activity
The participants on the supply side operate for similar reasons. Thus, the supply of foreign currency to the home country results from purchases of home exports, unilateral transfers to home country, investment income payments, foreign direct investments and portfolio investments, placement of bank deposits and speculation.
We shall now look into how the foreign exchange markets work. Similar to any standard market, the exchange market also faces a downward-sloping demand curve and an upward-sloping supply curve.
Figure 4.4.1
Determination of Nominal Exchange Rate
The equilibrium rate of exchange is determined by the interaction of the supply and demand for a particular foreign currency. In figure 4.4.1, the demand curve (D$) and supply curve (S$ )of dollars intersect to determine equilibrium exchange rate eeq with Qe as the equilibrium quantity of dollars exchanged.
No comments:
Post a Comment