AP Macroeconomics

The Foreign Exchange Market: Why Money is Just Like Cookies

The foreign exchange market is where currencies are bought and sold, functioning like any other commodity market. When demand for one currency increases, it appreciates while the other currency must depreciate, following the rule of opposites.

Key Takeaways

What shifts Demand for USD? (US Interest Rates, Demand for US Goods/Assets, Foreign Income)
What shifts Supply of USD? (Foreign Interest Rates, Demand for Foreign Goods/Assets, US Income)
The Rule of Opposites: If Currency A Appreciates, Currency B must Depreciate
How does interest rate differential affect Forex? (Higher US rates → Increased demand for USD → USD Appreciates)

Stop Reading. Start Drawing.

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Graph Gym Challenge

Draw the market for the U.S. Dollar. Show the impact if U.S. interest rates become higher than those in Europe.

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Instructions

Draw the market for the U.S. Dollar. Show the impact if U.S. interest rates become higher than those in Europe.

Check Your Understanding

Question 1 of 2

In a floating exchange rate system involving only the U.S. dollar and the Euro, if the Euro appreciates in value, what must necessarily happen to the U.S. dollar?

The U.S. dollar depreciates.

The U.S. dollar also appreciates.

The value of the U.S. dollar remains unchanged.

The supply of the U.S. dollar shifts to the left.