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AP Economics. Mr. Bernstein Module 42: The Foreign Exchange Market April 23, 2014. AP Economics Mr. Bernstein. The Foreign Exchange Market Objectives - Understand each of the following: The role of the Foreign Exchange market and the exchange rate

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Ap economics

AP Economics

Mr. Bernstein

Module 42:

The Foreign Exchange Market

April 23, 2014


Ap economics mr bernstein

AP EconomicsMr. Bernstein

The Foreign Exchange Market

Objectives - Understand each of the following:

  • The role of the Foreign Exchange market and the exchange rate

  • The importance of real exchange rates and their role in the current account


Ap economics mr bernstein1

AP EconomicsMr. Bernstein

Exchange Rates

  • Loanable Funds Market models flow of financial assets into and out of the Capital Account…and…

  • Goods and Services flow into and out of the Current Account

  • The Exchange Rate insures Current Account minus Capital Account = 0

  • Currencies appreciate and

    depreciate vs. one another


Ap economics mr bernstein2

AP EconomicsMr. Bernstein

Equilibrium Exchange Rates

  • FX rate is really just a price

  • Follows Laws of

    Supply and Demand

  • Labeling: think

    “bottom/bottom”

  • D slopes downward:

    Lower USD makes

    US products more

    attractive to Europeans


Ap economics mr bernstein3

AP EconomicsMr. Bernstein

Inflation and Real Exchange Rates

  • Example: Real Mexican Peso Exchange Rate =

    MXN/USD FX rate * (CPIMEX / CPIUSA)

  • Economists may refer to nominal and real exchange rates


Ap economics mr bernstein4

AP EconomicsMr. Bernstein

Purchasing Power Parity

  • PPP = Exchange rate where basket of goods and services would cost the same in each country

  • Example: Basket of goods and services in US costs $100 and in Mexico costs MXN1,000. PPP = 10 MXN per USD


Ap economics mr bernstein5

AP EconomicsMr. Bernstein

FX rates as of 4/20/14


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