1. Slides By John Dawson and Kevin Brady Begin Exchange Rates Interactive Examples Material from this presentation can be found in: Chapter 26 To navigate, please click the appropriate green buttons. (Do not use the arrows on your keyboard) CoreEconomics, 2e

2. Answer Exchange Rates QUESTION 1: Over the last year, the U.S. dollar per British pound exchange rate has declined from $1.77 per pound to $1.52 per pound. Does this imply a strengthening or weakening of the pound and the dollar? Explain. Interactive Examples

3. Next Question Exchange Rates ANSWER TO QUESTION 1: The decline in the dollar-pound exchange rate implies a weakening (or depreciation) of the pound and a strengthening (or appreciation) of the dollar. The pound has weakened because it now buys only 1.52 dollars, compared to 1.77 dollars previously. Alternatively, the dollar has strengthened because it now takes only $1.52 to buy a pound, compared to $1.77 previously. Interactive Examples

4. Answer Exchange Rates QUESTION 2: In early 2010, a debt crisis in Greece and several other European nations caused the euro to become a less desirable currency relative to the U.S. dollar. Draw a graph of the market for euros and demonstrate how the dollar-euro exchange rate is affected by this development. Does this imply a strengthening or weakening of the euro and the dollar? Interactive Examples

5. Next Question Exchange Rates ANSWER TO QUESTION 2: If the debt crisis causes the euro to become less desirable relative to the dollar, the demand for euros will decrease. This is shown in the graph below. The decrease in demand for euros causes a depreciation (weakening) of the euro or appreciation (strengthening) of the dollar. Note that when drawing the market for euros, the price of euros (the dollar per euro exchange rate) is shown on the vertical axis, where a decrease implies a depreciation of the euro. Interactive Examples

6. Answer Exchange Rates QUESTION 3: During the financial crisis of 2008, the Federal Reserve dramatically increased the supply of dollars to prevent a collapse of the financial system. Draw a graph of the market for dollars and demonstrate how the dollar-euro exchange rate will be affected. Does this imply a strengthening or weakening of the euro and the dollar? Interactive Examples

7. Next Question Exchange Rates ANSWER TO QUESTION 3: The Fed’s action increased the supply of dollars. This is shown in the graph below. The increase in supply of dollars causes a depreciation (weakening) of the dollar or appreciation (strengthening) of the euro. Note that when drawing the market for dollars, the price of dollars (the euro per dollar exchange rate) is shown on the vertical axis, where a decrease implies a depreciation of the dollar. Interactive Examples

8. Answer Exchange Rates QUESTION 4: Suppose a pound of fine chocolate costs $5 in the U.S. and 60 kroner in Norway. If the exchange rate between kroner and dollars is 6 kroner per dollar, what is the real exchange rate between the U.S. and Norway? Interactive Examples

9. The End Exchange Rates ANSWER TO QUESTION 4: Remember that the real exchange rate tells us the ratio at which we can exchange the goods from one country for the goods from another country. At an exchange rate of 6 kroner per dollar, we can calculate the dollar price of chocolate in Norway as 60 kroner/pound ÷ 6 kroner/dollar = 10 dollars/pound. Since a pound of chocolate in the U.S. costs $5, the real exchange rate would be 1 pound of Norwegian chocolate per 2 pounds of U.S. chocolate (1:2), or equivalently ½ pound of Norwegian chocolate per pound of U.S. chocolate (½:1). Interactive Examples