Foreign Exchange

by Daniel Johnson & Junior Jean-Louis

Key Vocabulary for Foreign Exchange

  1. Foreign exchange market - the market in which the currency one is exchanged for the currency of another
  2. Foreign exchange rate - the price at which one currency exchanges for another
  3. Currency appreciation - the rise in the value of one currency in terms of another currency
  4. Currency depreciation - the fall in the value of one currency in terms of another currency
  5. U.S. interest rate differential - the U.S. interest rate minus the foreign interest rate
  6. Debtor nation - a country that during its entire history has borrowed more from the rest of the world than it has lent to the rest of the world
  7. Creditor nation - a country that during its empire history has invested more in the rest of the world than other countries have invested in it
  8. Net borrower - a country that is borrowing more from the rest of the world than it is lending to the rest of the world
  9. Net lender - a country that is lending more to the rest of the world than it is borrowing from the rest of the world

General Notes and Tips

Currency Markets


When nations trade goods and services, they are implicitly trading currency. The rate of exchange between two currencies is determined in the "foreign currency market". Some nations fix their exchange rates, while others are allowed to "float" with the forces of demand and supply.


TIPS



  • The exchange rate between two currencies tells you how much of one currency you must give up to get one unit of the second currency.


Example: If $2 = 1 euro, $1 = .5 euro



  • If the Fed increases money supply: interest rate decreases, demand for $ decreases, Depreciates the $, U.S. Net Exports increases, Aggregate Demand increases
  • If the Fed decreases money supply: interest rate increases, demand for $ increases, Appreciates the $, U.S. Net Exports decreases, Aggregate Demand decreases.

The Demand for Dollars

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Practice AP Questions

1. You hear that the United States has a negative balance in the current account. With this information we conclude that


A. there is a trade deficit

B. there is a capital account deficit

C. there is a capital account surplus

D. more U.S. dollars are being sent abroad than foreign currencies are being sent to the United States

E. there is a trade surplus


2. Which of the following is a consequence of a protective tariff on imported steel?


A. Net exports fall

B. Income is transferred from domestic steel consumers to domestic steel producers

C. Allocative efficiency is improved

D. Income is transferred from domestic steel to foreign steel producers

E. Aggregate supply increases


3. When the United States places an import quota on imported sugar, we expect which of the following effects?


A. Consumers seek substitutes for sugar and products that use sugars

B. Consumers consume more sugar and products that use sugar

C. The supply of sugar increases

D. Net exports in the United States fall

E. The government collects revenue on every ton of imported sugar

Sources

AP Macroeconomic 5 Steps Book

Economic Textbook

AC/DC Econ