Submitted by: Submitted by renee06
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Category: Business and Industry
Date Submitted: 05/03/2016 11:58 AM
Exchange rate
Currency is just like any other commodity in the market. Its rates are determined by demand and supply factors. However, it depends with the currency of a country whether it is fixed or pegged, free-floating or a hybrid of the two. The free floating case is what involves the market forces in determining the currency rates (Rosenberg & Michael, 13).
Taking the example of two trading partners or countries, that is the US and Australia. This makes the dollar to be needed in both the US and the Australian market. The Australian market needs a different amount of dollars in relation to the US market. The Americans will always want to avail a certain number of dollars in the market for the Australians. The price for the dollars will be the nominal exchange rate. If the exchange rate is high, there will be less demand of the dollars by the Australians (just as one would like to buy few oranges if they were expensive). In this situation, the Americans would want to avail more dollars as they desire to obtain more from it (like the orange farmer). When the supply will be equal to the demand, we obtain the equilibrium exchange rate. In the foreign market, we can determine the dollars bought and sold.
According to the diagram above, the Australian buyers (persons who hold US dollars) are willing to purchase the quantity indicated by the demand curve (DD) at each potential exchange rate. The quantities of the Australian dollars available in the market for sale (persons who hold Australian dollars) are represented by the supply curve (SS) at each potential exchange rate. The equilibrium exchange rate stands at $A 1.00 = $US 0.50. Q1 is the equilibrium quantity demanded and supplied Australian dollars. At any exchange rate beyond the equilibrium, say $A 1.00 = $US 0.60, there is an excess supply of the Australian dollars hence forcing market forces to push the exchange rate down back to the equilibrium. If it is below the equilibrium, say $A 1.00 =...