Exchange rates: value of one currency expressed in terms of another currency.

Types of exchange rates

1. Floating Exchange rates: Value is determined by demand and supply.

Changes to exchange rate:

Appreciation: rise of one currency in terms of another. Rise in Demand or fall in supply. Specifically in a floating exchange system.

Depreciation: Fall of one currency in terms of another. Fall in Demand or rise in supply. Specifically in a floating exchange system.

Causes of Changs:

• Foreign demand for exports → affects demand of currency
• Domestic demand for imports → affects supply → as domestic currency needs to be exchanged.
• Relative interest rate changes: Higher interest rates → attract foreign capital from other → raising demand for domestic and raising supply for foreign
• Relative rates of inflation: High inflation → reduces export competitiveness → fall in demand for currency.
• Investment from abroad:
• Changes in incomes: high incomes → more demand for imports → increases supply
• Speculation
• Foreign currency reserves: central bank → use foreign currency to buy currency or use its currency to buy foreign currency influencing demand supply.

Effects

High Exchange Rate: