6.4 Effect of Changes in Policies and Economic Conditions on the Foreign Exchange Market

a. Explain (using graphs as appropriate) the determinants of currency demand and supply. b. Explain (using graphs as appropriate) how changes in demand and supply in the foreign exchange market affect the equilibrium exchange rate.

• Factors that shift the demand for a currency (such as the demand for that country’s goods, services, or assets) and the supply of a currency (such as tariffs or quotas on the other country’s goods and services) change the equilibrium exchange rate.
• Fiscal policy can influence aggregate demand, real output, the price level, and exchange rates.
• Monetary policy can influence aggregate demand, real output, the price level, and interest rates, and thereby affect exchange rates.
• Enduring understanding MKT-5: The interaction of buyers and sellers exchanging the currency of one country for the currency of another determines the equilibrium exchange rate in a flexible exchange market and influences the flow of goods, services, and financial capital between countries.