1. FOREX: Mechanics of Foreign Exchange
FOREX: Mechanics of Foreign Exchange
AP Macroeconomics

2. Foreign Exchange (FOREX)
Buying and selling of currency
In order to buy souvenirs in France, Americans must sell their Dollars and buy Euros.

3. Foreign Currency & Exchange Game
Price (in Yen)
Round 1
220
210
190
180
170
160
150
140
130
120
110
100 90 80 70 60 50
Round 2
Round 3

4. Floating Exchange Rates
Exchange rate regime where the value of a currency is allowed to be determined solely by the demand for and supply of the currency on the FOREX. No government intervention.

5. Appreciation and Depreciation
Appreciation of a currency occurs when the exchange rate of that currency increases (e↑)
Depreciation of a currency occurs when the exchange rate of that currency decreases (e↓)
I’m excited for my semester in Europe! I exchanged my US $ for Euros so I can buy stuff in France!

6. FOREX is Function of Supply and Demand .: $ depreciates relative to €
S$ (from the US)
S$ 1
Price of US$ in Euros e e1
D$ (from the EU) q q1
Q of US$
S$  .: e (ex. rate) ↓ & Q$ ↑
.: $ depreciates relative to €

7. FOREX is Function of Supply and Demand
Price of Euros in US$
Q of€
S€ from Europe
D € e q
D € 1 from US e1 q1
D €  .: e ↑ & Q € ↑
.: € appreciates relative to the $
Q of US$
S$ (from US)
D$ (from the EU) e q
S$  .: e (ex. rate) ↓ & Q$ ↑
.: $ depreciates relative to €
S$ 1 e1 q1
Price of US$ in Euros

8. Exchange Rate Determinants
Americans want to travel to Europe because they’re escaping the political realities of the United States.
Consumer Tastes
Exchange Rate Determinants

9. .: $ depreciates relative to €
U.S. Dollar Market
€ / $ S$
S$ 1 e
We’re going to Euro-Disney because it’s groovy! We’ll trade our dollars! e1 D$ Q$ q q1
S$  .: e (ex. rate) ↓ & Q$ ↑
.: $ depreciates relative to €

10. Japanese video games become popular with US children.q S D e q
Japanese video games become popular with US children.

11. Exchange Rate Determinants
The Japanese economy is doing well and incomes are up. Japanese people therefore buy more domestic AND foreign products.
Relative Income
Exchange Rate Determinants

12. .: ¥ depreciates relative to €
Japanese Yen Market S¥
Price of ¥ in €
S¥1 e e1
My Japanese company is performing well. I’m ready to buy some European swag. D¥ Q¥ q q1
S¥ → .: e ↓ & Q¥ ↑
.: ¥ depreciates relative to €

13. S D e q S D e q
French tourists flock to Mexico’s beaches after receiving big holiday bonuses.

14. Exchange Rate Determinants
One result of Brexit has been high inflation in Britain. As a result of their inflation, American goods and services feel less expensive to the English relative to buying from local sources. Brits will buy more American products.
Relative Price Level
Exchange Rate Determinants

15. .: $ appreciates relative to the £
US $ Market
£/$ S$ e1
I’ll buy my shagadellic stuff from America, Baby! e
D$1 D$ Q$ q q1
D$  .: e ↓ & Q¥ ↓
.: $ appreciates relative to the £

16. The prices of US goods rise relative to the prices of German goods.q S D e q
The prices of US goods rise relative to the prices of German goods.

17. Exchange Rate Determinants
If investors expect that Swiss interest rates will climb in the future at a higher rate than US rates, then investors will demand fewer US$ with hopes of earning the higher rates of return in Switzerland.
Change in Interest Rates
Exchange Rate Determinants

18. .: $ depreciates relative to the Franc
US $ Market
Franc/$ S$ e e1
I was going to move my money to America, but I think I’ll keep it in my Swiss bank account instead. D$
D$ 1 Q$ q1 q
D$  .: e ↓ & Q$ ↓
.: $ depreciates relative to the Franc

19. Interest rates in the US rise faster than interest rates in Canada.q S D e q
Interest rates in the US rise faster than interest rates in Canada.

20. Exchange Rate Determinantsq
After Donald Trump give a speech about building the wall, the Mexican Peso tanked.
Speculation
Exchange Rate Determinants

21. Exports and Imports
The exchange rate is a determinant of both exports and imports
Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper thus reducing exports and increasing imports
Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing exports and reducing imports

23. The trifecta is just child’s play… This is the
P E N T a F E C T A ! ! !

24. Expansionary Monetary Policy to Counteract a Recession w/ reinforcing effect on Net Exports
Res. Ratio
Disc. Rate
Buy Bonds 
ER ,therefore MS causing i% which leads to IG     = 
so AD ,resulting in PL and GDPR ,making u%    
And now! Because i% either D$ or S$ which causes $ making U.S. goods
relatively and foreign goods relatively causing X and
M which means XN thereby reinforcing the increase in AD already caused by
the increase in IG.    
cheaper
more expensive   
AD = Aggregate Demand
PL = Price Level
GDPR = Real Gross Domestic Product
u% = Unemployment Rate
S$ = Supply of Dollars in FOREX
M = Imports, XN = Net Exports
ER = Excess Reserves
MS = Money Supply
i% = Nominal Interest Rate
IG = Gross Private Investment
D$= Demand for dollars in FOREX
X = Exports

25. Contractionary Monetary Policy to Counteract Inflation w/ reinforcing effect on Net Exports
Res. Ratio
Disc. Rate
Sell Bonds 
ER ,therefore MS causing i% which leads to IG     = 
so AD ,resulting in PL and GDPR ,making u%    
And now! Because i% either D$ or S$ which causes $ making U.S. goods
relatively and foreign goods relatively causing X and
M which means XN thereby reinforcing the decrease in AD already caused by
the decrease in IG.    
more expensive
cheaper   
AD = Aggregate Demand
PL = Price Level
GDPR = Real Gross Domestic Product
u% = Unemployment Rate
S$ = Supply of Dollars in FOREX
M = Imports, XN = Net Exports
ER = Excess Reserves
MS = Money Supply
i% = Nominal Interest Rate
IG = Gross Private Investment
D$= Demand for dollars in FOREX
X = Exports

26. Expansionary Fiscal Policy Side-effect: ‘Crowding-out’ of Investment and Net Exports
A possible side-effect of increased government spending
and reduced taxes is a budget deficit which may lead to
the ‘crowding-out’ of Gross Private Investment (IG) and
Net Exports (XN) 
When G or T , then government must borrow in order to continue
spending. This leads to an increase in the demand for loanable funds
or a decrease in the supply of loanable funds, which results in r % .
This change in r % leads to IG . In addition, the increase in r% causes
D$ and/or S$ as investors seek higher returns in the U.S. This leads to
$ which leads to X and M , so XN . Because IG and XN are direct
components of AD, these decreases offset some of the increase in AD.         

27. Contractionary Fiscal Policy Side-effect: ‘Crowding-in’ of Investment and Net Exports
A possible side-effect of decreased government spending
and increased taxes is a budget surplus which may lead to
the ‘crowding-in’ of Gross Private Investment (IG) and
Net Exports (XN)
When G or T , then government develops a budget surplus
This leads to a decrease in the demand for loanable funds
or an increase in the supply of loanable funds, which results in r % .
This change in r % leads to IG . In addition, the decrease in r% causes
D$ and/or S$ as investors seek higher returns abroad. This leads to
$ which leads to X and M , so XN . Because IG and XN are direct
components of AD, these increases offset some of the decrease in AD.          

28. Fixed Exchange Rate
Exchange rate regime where the value of a currency is fixed, or pegged, to the value of another currency, or to the average value of a selection of currencies, or to the value of some other commodity, such as gold.
As the value of the variable that the currency is pegged to changes, then so does the value of the currency.

29. How do they do it?

30. Managed exchange rates
Be realistic… there’s no completely free-floating currency. In extreme circumstances, there will be intervention to stabilize the exchange rate.
The currency is allowed to float, but with some element of interference from the government.

32. Let’s draw this quote!
In "managed float" cases (28 percent), market forces are allowed to play, but with the government buying or selling their own currency in the market, as needed… For example the Reserve Bank of India will intervene by buying dollars when the rupee appreciates too much and by selling them when its currency depreciates significantly.

33. What’s up with China?

34. Self-correcting Balance of Trade$  X  M  X  M 
.: XN 
.: XN  $ 

35. Self-correcting Balance of Trade$  X  M  X  M 
.: XN 
.: XN  $ 

36. AP FRQ 2008
2. Balance of payments accounts record all of a country’s international transactions during a year. (a) Two major subaccounts in the balance of payments accounts are the current account and the capital account. In which of these subaccounts will each of the following transactions be recorded? (i) A United States resident buys chocolate from Belgium. (ii) A United States manufacturer buys computer equipment from Japan. (b) How would an increase in the real income in the United States affect the United States current account balance? Explain. (c) Using a correctly labeled graph of the foreign exchange market for the United States dollar, show how an increase in United States firms’ direct investment in India will affect the value of the United States dollar relative to the Indian currency (the rupee).

37. 6 points ( ) (a) 2 points: • One point is earned for stating that the transaction will be recorded in the current account. (b) 2 points: • One point is earned for stating that the current account balance will decrease or move toward a deficit. • One point is earned for explaining that the increase in income causes imports to increase. (c) 2 points: • One point is earned for a correctly labeled graph of the foreign exchange market for the U.S. dollar. • One point is earned for shifting the supply of U.S. dollars to the right and showing a depreciation of the dollar.

38. AP FRQ: 2008 form B
2. Suppose that Mexico decreases its tariff rates on all of its imports of automobiles from abroad. (a) Will each of the following groups benefit from the decrease in the tariff rate? (i) Mexican consumers (ii) Mexican automobile manufacturers. Explain. (b) How would the decrease in the tariff rates affect each of the following in Mexico? (i) Current account balance. Explain. (ii) Capital account balance (c) Given the change in Mexico’s current account in part (b)(i), what will happen to the aggregate demand in Mexico?

39. 7 points ( ) (a) 3 points: • One point is earned for stating yes for Mexican consumers. • One point is earned for stating no for Mexican manufacturers. • One point is earned for the explanation that reducing tariffs will cause the domestic price of automobiles to fall in Mexico, lowering the production of cars in Mexico. (b) 3 points: • One point is earned for indicating that the current account will move toward a deficit. • One point is earned for the explanation that the reduction in tariff increases imports relative to exports. • One point is earned for stating that the capital account will move toward a surplus. (c) 1 point: • One point is earned for concluding that aggregate demand will decrease.