1. Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. CHAPTER 10 How Exchange Rates Are Determined

2. Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. The Exchange Rate Since 1980 *Includes Switzerland, Germany, Japan, France, United Kingdom, Canada, Italy, Netherlands, Belgium/Luxembourg, Sweden, Spain, Ireland, Austria, Finland, Portugal, and Australia. SOURCE: Global Financial Data, Los Angeles, California. Trade-Weighted Dollar* (1980-September 28, 2001) 140.000 130.000 120.000 110.000 100.000 90.000 80.000 70.000 60.000 50.000 40.000 30.000 20.000 10.000 1985199019952000

3. Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. The Foreign Exchange Market U.S. Purchases (Demand) Foreign Goods, Services, and Securities Foreigners Purchase (Demand) U.S. Goods, Services, and Securities United States Rest of the World Foreign Exchange Market U.S. Supplies Dollars as Foreigners Supply Yen U.S. Demands Yen to Pay Foreigners as Foreigners Demand Dollars to Pay U.S. Yen Per Dollar Dollars Supply Dema nd $Yen

4. Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. The Market for Dollars Yen/Dollar Quantity of Dollars/Month Demand for Dollars A Supply of Dollars 100

5. Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. Changes in the Exchange Rate: The Role of Changes in Supply Yen/Dollar Exchange Rate Quantity of Dollars/Month Demand for Dollars A Supply of Dollars 100 50B Supply of Dollars after Rise in U.S. Income

6. Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. Changes in the Exchange Rate: The Role of Changes in Demand Yen/Dollar Exchange Rate Quantity of Dollars/Month Demand for Dollars A Supply of Dollars 100 50 B Demand for Dollars after Rise in U.S. Prices

7. Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. A Hypothetical and Simplified Balance of Payments for the U.S. Economy in the Year 2005 (in Billions of Dollars) AccountComponentReceiptsPayments Balance Use of $ Source of $by foreigners Current(2) Merchandise exports+$400 (4) Balance of trade (3) Merchandise imports-600 (2) + (3) = -$200 (5) Net exports of services+$50(6) Balance of goods and services: (4) + (5) = -$150 = net exports (7) Net unilateral transfers-$30(1) Balance on current account: (6) + (7) = -$180 Capital(9) Capital inflows+280(8) Balance on capital account (10) Capital outflows-$100 (9) + (10) = $180 Balance ofTotal usesTotal sources Payments+$730-$730(1) + (8) = 0