AP Economics Mr. Bernstein Module 42: The Foreign Exchange Market April 15, 2015 AP Economics Mr. Bernstein The Foreign Exchange Market Objectives - Understand each of the following: The role of the Foreign Exchange market and the exchange rate The importance of real exchange rates and their role in the current account 2 AP Economics Mr. Bernstein Exchange Rates Loanable Funds Market models flow of financial assets into and out of the Capital Accountand Goods and Services flow into and out of the Current Account The Exchange Rate insures Current Account minus Capital Account = 0 Currencies appreciate and depreciate vs. one another 3 AP Economics Mr. Bernstein Equilibrium Exchange Rates FX rate is really just a price Follows Laws of Supply and Demand Labeling: think bottom/bottom D slopes downward: Lower USD makes US products more attractive to Europeans 4 AP Economics Mr. Bernstein Inflation and Real Exchange Rates Example: Real Mexican Peso Exchange Rate = MXN/USD FX rate * (CPI MEX / CPI USA ) Economists may refer to nominal and real exchange rates 5 AP Economics Mr. Bernstein Purchasing Power Parity PPP = Exchange rate where basket of goods and services would cost the same in each country Example: Basket of goods and services in US costs $100 and in Mexico costs MXN1,000. PPP = 10 MXN per USD 6 AP Economics Mr. Bernstein FX rates as of 4/14/15 7