Learning objectives

• Students will apply market analysis to the exchange of currencies.
• By graphing currency markets, students will recognize the changing value of currency.

Starter discussion
Ask students to identify items they own that were produced in other countries. Ask them to look at the labels on their clothes, shoes, watches, and backpacks. Use this conversation to generate a discussion of the types of currencies used in these countries.

Select an item mentioned by a student and ask what currency the producer would have accepted for the item. For instance, a producer in India would have wanted rupees for his product, and a producer in France would have wanted euros for her product. Discuss the trading of currency in terms of “buying” and “selling” currency, so that the market analysis follows naturally. Help students see that the foreign currency would be purchased with dollars.

Here are some websites with currency information or online currency converters:

  www.ny.frb.org/markets/foreignex.html
  www.oanda.com/converter/classic

Instructional plan
Using the following example, explain the components of two currency markets—U.S. dollars (USD) bought with Japanese yen (JPY), and Japanese yen bought with U.S. dollars—and the relationship between them. (Assume that these two currency markets are the only two in existence.)

Figure 1: Supply and Demand Curves for USD and JPY

Key ideas to explain:

• The supplier of dollars is also the demander of yen. Therefore, both the supply of dollars and the demand for yen represent that aspect of the transactions. Conversely, the supplier of yen is also the demander of dollars so those two curves reflect that aspect of the transactions.
• The supply curve for dollars is upward sloping because the quantity of dollars supplied increases at higher prices (in foreign currency). This is not the money market. This represents the dollars that people are willing and able to supply in exchange for foreign currency. (Same analysis for supply of yen)
• The demand curve for dollars is downward sloping because at higher prices (in foreign currency) fewer people are willing to buy dollars, and at lower prices more people are willing to buy dollars. (Same analysis for demand for yen) The demand for currency is primarily a derived demand. People who buy currency buy it in order to buy something else.
• The same equilibrium exchange rate is reflected in both currency markets. In the above example, $1 = ¥100, therefore ¥1 = $0.01.
• Increasing demand in the market for either dollars or yen is accompanied by an increasing supply in the other market. Decreasing demand in either the dollar or yen market is accompanied by decreasing supply in the other market.
• A changing equilibrium exchange rate changes the international value of both currencies.
• A currency that increases in value (buys more of another currency) is an appreciating currency and a currency that decreases in value (buys less of another currency) is a depreciating currency.

Using the example below, show an increase in demand by U.S. consumers for autos produced in Japan.

• When there is an increased demand for yen in order to purchase autos, the price of yen in dollars increases.
• When there is an increased supply of dollars needed to purchase the yen, the price of dollars in yen declines.

Questions to discuss with students:

• Assume that the price of a dollar is now 50 yen.
  • What is the dollar price of a yen? ($0.02)
  • Has the dollar appreciated or depreciated in relationship to the yen? (Depreciated)
  • Has the yen appreciated or depreciated in relationship to the dollar? (Appreciated)
• Assume that holders of yen decide to purchase iPods from the United States. Explain the impact on both currency markets. Predict the change in the international value of the dollar and the yen. (Demand for the dollar increases and supply of the yen increases. The dollar appreciates and the yen depreciates.)

Practice Activity: Task Cards for Currency Markets
Place students in eight small groups numbered 1 through 8. Give each group a task card. Tell the students that they will have three minutes (or the amount of time that you think is appropriate) to complete the task. After you call time, have each group pass their card to the next group in order. Group 1 passes their card to group 2, and so on (group 8 passes their card to group 1).

Continue the process, giving groups three minutes per task card. Circulate among the groups answering or asking questions. There should be enough time left over to go over the answers all together as a class.

An incentive for the students might be a quiz the next day over these topics or free homework passes for groups that have correct answers for all questions.

Answers for task cards:

1.

The supplier of dollars is the demander of euros and is represented by the demand curve in the euro market.

2.

The demander of dollars is the supplier of euros and is represented by the supply curve in the euro market.

3. Decreasing supply or increasing demand in the currency market for dollars could cause the dollar to appreciate. The dollar appreciates when it buys an increased amount of a foreign currency.

4. Demand for pesos will increase in order to purchase products or make payments in Mexico.

5. Increasing supply or decreasing demand in the currency market for dollars could cause the dollar to depreciate. The dollar depreciates when it buys a smaller amount of a foreign currency.

6.

At higher dollar prices for euros the quantity supplied of euros will increase. At lower dollar prices for euros the quantity supplied of euros will decrease.

7.

The quantity demanded of rupiahs is lower at higher dollar prices and higher at smaller dollar prices for rupiahs.

8.

The supply of pounds increases in order to buy more dollars. The hybrids produced in the United States will be paid for in dollars.

Short free-response question:

Draw a correctly labeled currency market for the Singapore dollar (SGD). Assume that exports of silk fabric from Singapore increase.

• Show and explain the impact on the currency market for the Singapore dollar (SGD).
• Explain the impact from the increase in exports on the international value of the Singapore dollar.

Answer and scoring rubric for short free-response question: 5 points        

1 point for correctly labeled model
1 point for D2 shown to the right of D1
1 point for showing that demand for SGD increases in order to purchase products in Singapore
1 point for showing increased price (in another currency) of SGD (on model)
1 point for showing increasing value of currency (must be consistent with model)

Conclusion: Teaching currency markets in macroeconomics early illustrates for students the use of basic economic models for international concepts. This gives students a good basis for a later discussion of the impact on the affordability of imports and exports caused by a changing international value of currency. Additionally, the understanding of the basic framework of currency markets allows students to later learn to use the model in showing changes in the determinants of exchange rates. It also saves time in the course as students learn about changes in net exports that occur with fiscal policy and monetary policy. The students come to the discussion of net exports with an understanding of the currency-market model. They have several opportunities to use the model and improve their understanding of the model and concept.