Equilibrium exchange rate, Microeconomics

Equilibrium Exchange Rate:

The theory of exchange rate determination explains how demand and supply of foreignexchange interact and jointly determine the equilibrium exchange rate. 

 

1264_Equilibrium Exchange Rate.png

 

As seen earlier, the demand schedule for Indian rupees (or supply schedule of foreigncurrency) arises from the foreign demand for Indian exports. Similarly, the supplyschedule of Indian rupees (or demand schedule for foreign currency) arises from theIndian demand for foreign goods or imports. Together, they determine the equilibriumexchange rate (R*)Suppose there is an exogenous increase in income in the US and therefore an increasein demand for Indian goods.  Correspondingly, the demand schedule for Indian rupeesshifts to D1.  The resultant equilibrium exchange rate (R*1 ) indicatesthat the Rupee has appreciated against the dollar.  

Similarly, if Indian imports increase(relative to the exports) then the supply curve (SRs) shifts to the right resulting in the depreciation of Indian rupee from R2 to (R*1).Thus, in a flexible exchange rate regime, market demand for and supply of a country'scurrency determines the changes in exchange rate.  As the demand and supply schedules for currency are determined by many forces, there would be a tendency for high volatilityof exchange rates in this regime. As there would be no intervention by the CentralBank in determining the exchange rate, the BoP will always be in equilibrium. It meansthat the exchange rate adjusts to make the balances in current and capital accounts sumto zero. 

Posted Date: 11/10/2012 7:06:11 AM | Location : United States







Related Discussions:- Equilibrium exchange rate, Assignment Help, Ask Question on Equilibrium exchange rate, Get Answer, Expert's Help, Equilibrium exchange rate Discussions

Write discussion on Equilibrium exchange rate
Your posts are moderated
Related Questions
demand elasticity in urdu

Employer’s Estimates of Future Manpower Requirements One of the parameters of demand for employment in a firm or a factory or an establishment is the level of capital investme

Determinants of quantity supplied of a good The quantity of supplied of a product is influenced by factors such as the market price of the commodity, prices of inputs, techno


determination of rent

Sally recently finished her full-time training and received certification as a nurse’s aid at the end of August. She sent out applications to prospective employers during the last

what the company do?

Question 1: Define the concepts price elasticity of demand, income elasticity of demand and cross elasticity of demand and explain how these concepts can be useful to the man

The Short Run versus long Run - Short-run: Period of time in which the quantities of one or more production factors cannot be changed. These inputs are called as fi

1) Lynne's income is £2, 000 and she is risk averse. The probability of someone slipping on her stairs is 1/8. If this happens, she will be sued for £1, 000 and will have to pay th