5.1 Graphing Exercise: Exchange Rates

United States exporters wish to be paid for their goods and services in dollars, yet the buyers in foreign countries possess their own local currencies, not dollars. Likewise, United States importers must pay in foreign currencies but possess only dollars. A market for foreign exchange allows U.S. firms and individuals - supplying dollars and demanding foreign currencies - to make an exchange with foreign firms and individuals - demanding dollars and supplying their own currencies.

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Exploration: What factors cause the exchange rate to change?

Consider the market for Japanese yen shown in the graph. The price is measured in the number of U.S. dollars required to purchase one Japanese yen. If this price rises, we would say that the yen has appreciated (and the dollar has depreciated.) Likewise, if this price falls, we would say that the yen has depreciated (and the dollar has appreciated.) For simplicity, we'll assume that the U.S. and Japan are the only two countries trading in this market. Currently, the market is in equilibrium - there is neither a surplus nor a shortage of yen. Using the interactive graph, you can illustrate the impacts of changes in exports or imports on the market for foreign exchange. Click on the label of the appropriate curve and drag it to a new location to shift either demand or supply; click on the New Equilibrium to observe the market adjustments necessary to restore equilibrium.

1. Suppose U.S. citizens wish to import more goods from Japan. Will the yen appreciate or depreciate relative to the dollar?
   See answer here
2. Alternatively, suppose Japanese citizens wish to import more goods from the U.S. Will the yen appreciate or depreciate relative to the dollar?
   See answer here