The result is that the equilibrium exchange rate rises from 10 cents/peso to 12 cents/peso and the equilibrium exchange rate rises from 85 billion to 90 billion pesos as the equilibrium moves from E 0 to E 1.įigure 29.6 Exchange Rate Market for Mexican Peso Reacts to Expectations about Future Exchange Rates An announcement that the peso exchange rate is likely to strengthen in the future will lead to greater demand for the peso in the present from investors who wish to benefit from the appreciation. Conversely, the supply of pesos shifts to the left, from S 0 to S 1, because investors will be less willing to give them up. Demand for the Mexican peso shifts to the right, from D 0 to D 1, as investors become eager to purchase pesos. Figure 29.6 illustrates the likely effects of such an article. For example, imagine that a leading business newspaper, like the Wall Street Journal or the Financial Times, runs an article predicting that the Mexican peso will appreciate in value. One reason to supply a currency-that is, sell it on the foreign exchange market-is the expectation that the currency's value is about to decline. One reason to demand a currency on the foreign exchange market is the belief that the currency's value is about to increase. What factors would cause the demand or supply to shift, thus leading to a change in the equilibrium exchange rate? We discuss the answer to this question in the following section. In the actual foreign exchange market, almost all of the trading for Mexican pesos is for U.S. Note that the two exchange rates are inverses: 10 pesos per dollar is the same as 10 cents per peso (or $0.10 per peso). currency for each Mexican peso and a total volume of 85 billion pesos. The demand curve (D) for Mexican pesos intersects with the supply curve (S) of Mexican pesos at the equilibrium point (E), which is an exchange rate of 10 cents in U.S. The horizontal axis shows the quantity of Mexican pesos traded in the foreign exchange market. The vertical axis shows the exchange rate for Mexican pesos, which is measured in U.S. In both graphs, the equilibrium exchange rate occurs at point E, at the intersection of the demand curve (D) and the supply curve (S).įigure 29.5 (b) presents the same demand and supply information from the perspective of the Mexican peso. (b) The quantity measured on the horizontal axis is in Mexican pesos, while the price on the vertical axis is the price of pesos measured in U.S. dollars, and the exchange rate on the vertical axis is the price of U.S. Dollar and Mexican Peso Exchange Rate (a) The quantity measured on the horizontal axis is in U.S. Figure 29.5 Demand and Supply for the U.S.
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