Exchange Rates 3.2
IB Syllabus Requirements
Determination of freely floating exchange rates
• Explain that the value of an exchange rate in a floating system is determined by the demand for, and supply of, a currency.
• Draw a diagram to show determination of exchange rates in a floating exchange rate system.
HL Requirements:
Calculate the value of one currency in terms of another currency.
Calculate the exchange rate for linear demand and supply functions.
Plot demand and supply curves for a currency from linear functions and identify the equilibrium exchange rate.
Using exchange rates, calculate the price of a good in different currencies.
Causes of changes in the exchange rate
• Describe the factors that lead to changes in currency demand and supply, including foreign demand for a country’s exports, domestic demand for imports, relative interest rates, relative inflation rates, investment from overseas in a country’s firms (foreign direct investment and portfolio investment) and speculation.
• Distinguish between a depreciation of the currency and an appreciation of the currency.
• Draw diagrams to show changes in the demand for, and supply of, a currency.
HL Requirement:
• Calculate the changes in the value of a currency from a set of data.
The effects of exchange rate changes
• Evaluate the possible economic consequences of a change in the value of a currency, including the effects on a country’s inflation rate, employment, economic growth and current account balance.
Government Intervention
Fixed exchange rates
• Describe a fixed exchange rate system involving commitment to a single fixed rate.
• Distinguish between a devaluation of a currency and a revaluation of a currency.
• Explain, using a diagram, how a fixed exchange rate is maintained.
Managed exchange rates (managed float)
• Explain how a managed exchange rate operates, with reference to the fact that there is a periodic government intervention to influence the value of an exchange rate.
• Examine the possible consequences of overvalued and undervalued currencies.
Evaluation of different exchange rate systems
• Compare and contrast a fixed exchange rate system with a floating exchange rate system, with reference to factors including the degree of certainty for stakeholders, ease of adjustment, the role of international reserves in the form of foreign currencies and flexibility offered to policy makers.
Part 1: Freely Floating Exchange Rates and Causes for Changes in Exchange Rates
Goals for the day:
Determination of freely floating exchange rates
• Explain that the value of an exchange rate in a floating system is determined by the demand for, and supply of, a currency.
• Draw a diagram to show determination of exchange rates in a floating exchange rate system.
Causes of changes in the exchange rate
• Describe the factors that lead to changes in currency demand and supply, including foreign demand for a country’s exports, domestic demand for imports, relative interest rates, relative inflation rates, investment from overseas in a country’s firms (foreign direct investment and portfolio investment) and speculation.
• Distinguish between a depreciation of the currency and an appreciation of the currency.
• Draw diagrams to show changes in the demand for, and supply of, a currency.
2. Part 2 – Intro Worksheet
“Discussion Topic 19 – The Balance of Trade” (it’s really about exchange rates)
3. Part 3 – Practice
HW: Read pp 453-459
Part 2: The Effects of Exchange Rate Changes and Government Intervention
Goals for the lessons:
The effects of exchange rate changes
• Evaluate the possible economic consequences of a change in the value of a currency, including the effects on a country’s inflation rate, employment, economic growth and current account balance.
Government Intervention
Fixed exchange rates
• Describe a fixed exchange rate system involving commitment to a single fixed rate.
• Distinguish between a devaluation of a currency and a revaluation of a currency.
• Explain, using a diagram, how a fixed exchange rate is maintained.
Managed exchange rates (managed float)
• Explain how a managed exchange rate operates, with reference to the fact that there is a periodic government intervention to influence the value of an exchange rate.
• Examine the possible consequences of overvalued and undervalued currencies.
Evaluation of different exchange rate systems
• Compare and contrast a fixed exchange rate system with a floating exchange rate system, with reference to factors including the degree of certainty for stakeholders, ease of adjustment, the role of international reserves in the form of foreign currencies and flexibility offered to policy makers.
Review Questions:
1. What are the advantages and disadvantages of a high exchange rate?
2. Draw the exchange rate diagrams for the US and India if 1$ = 68 Rs
3. What would happen to the diagrams if the chairman of the US FED increased interest rates?
4. What are the pros and cons of doing this in terms of the entire Macro US economy? (Use an AD/AS diagram) then evaluate the decisions using CLASPP:
C: Conclusions
L: Long-term and Short term effects
A: Assumptions (Does the theory hold up in the real world? What assumptions (ie ceteris paribus) need to be made for this theory to work?
S: Stakeholders
P: Priorities of society and/or government
P: Pros and Cons
How does China Manipulate its Currency?