Chapter 5

It’s a Matter of Demand and Supply

In This Chapter

arrow Learning the basics about the demand–supply model

arrow How exchange rates are determined based on the demand–supply model

arrow Which factors change exchange rates

You may know today’s dollar–euro exchange rate, but it will be something else tomorrow or the next day. Why do exchange rates change? Reading this chapter is the first step in answering this question.

Economists don’t use a crystal ball to predict changes, although some people may think so! But economists have a pretty nice set of tools at their disposal for prediction. This chapter shows that the demand–supply framework enables you to predict the next period’s exchange rate. When you understand this framework, you’ll be able to predict the direction of the change in the exchange rate — in other words, whether a currency will depreciate or appreciate against another currency.

This chapter introduces a basic microeconomic approach to exchange rate determination. First, the market for oranges illustrates the demand–supply model. Then you can easily change the assumption from the market for oranges to the market for dollars or euros.

Apples per Orange, Euros per Dollar: ...

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