Exchange Rate Case Study

Q1: When determining what factors affect change on the exchange rate, the concept of supply and demand can be used to describe the overall behavior of those factors (Mishkin & Eakins, 2012). In regards to the exchange rate, demand is simply the desire that countries have towards obtaining currency foreign to their own. In a similar fashion, supply can be described as the amount of the currency a country supplies so that it can be exchanged to purchase goods priced in a foreign currency (McEarchin, 2012). Refocusing on how demand affects the exchange rate, there are seven factors that are taken into consideration. The first of those factors is the domestic interest rate, which causes a demand increase as it and the expected return on domestic assets increase (Mishkin & Eakins, 2012). The second factor that affects demand is the foreign interest rate. However, a change in the foreign interest rate creates a negative effect on demand, as an increase in foreign interest will cause demand for domestic assets to drop (Mishkin & Eakins, 2012). The third factor that has an effect on demand in regards to the exchange rate is the expected domestic price level. Like the foreign interest rate, a change in the expected domestic price level has a negative effect on the demand for domestic assets. In other words, as the expectation rise about the value …show more content…
The first of those factors is a country’s relative price level, which when elevated, causes the domestic currency to depreciate. Alternately, a drop in a country’s relative price level will cause its domestic currency to appreciate (Mishkin & Eakins, 2012). A way to think about how this factor works is that when the price of goods in one country increases, the demand for those goods will decrease and cause the value of the domestic currency to drop, which makes other countries products more attractive and their currency to