Question
How is foreign exchange rate determined in the market?
✓
Answer
The flexible exchange rate is determined by the forces of demand and supply of foreign exchange in the foreign exchange market.
The demand curve for foreign exchange $($say dollars$)$ varies inversely with the exchange rate.
As the exchange rate rises, less foreign exchange rate is demanded and vice versa.
The demand curve for foreign exchange is downward sloping.
The supply curve of foreign exchange $($say dollars$)$ varies directly with the exchange rate.
As the exchange rate rises, the supply of foreign exchange increases and vice versa.
The supply curve of foreign exchange is upward sloping.
The flexible exchange rate is determined at a point where the ‘demand for’ and ‘supply of’ foreign exchange are equal,
i.e., Demand for foreign exchange $($say dollars$) =$ Supply of foreign exchange $($say dollars$).$
The diagram illustrates determination of equilibrium exchange rate.
The diagram shows that demand for dollar $(D)$ and supply of dollar $(S)$ curves intersect each other at point $E.$
The equilibrium exchange rate is $OR$ and the equilibrium quantity is $OQ.$
The demand curve for foreign exchange $($say dollars$)$ varies inversely with the exchange rate.
As the exchange rate rises, less foreign exchange rate is demanded and vice versa.
The demand curve for foreign exchange is downward sloping.
The supply curve of foreign exchange $($say dollars$)$ varies directly with the exchange rate.
As the exchange rate rises, the supply of foreign exchange increases and vice versa.
The supply curve of foreign exchange is upward sloping.
The flexible exchange rate is determined at a point where the ‘demand for’ and ‘supply of’ foreign exchange are equal,
i.e., Demand for foreign exchange $($say dollars$) =$ Supply of foreign exchange $($say dollars$).$
The diagram illustrates determination of equilibrium exchange rate.
The diagram shows that demand for dollar $(D)$ and supply of dollar $(S)$ curves intersect each other at point $E.$
The equilibrium exchange rate is $OR$ and the equilibrium quantity is $OQ.$
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