Mechanisms of foreign exchange 

Foreign exchange 

-The buying and selling of currency 

-Any transaction that occurs in the balance of payment necessitates foreign exchange.

-The exchange rate is determined in the foreign currency market.

Changes in exchange rate

Exchange rates are a function of the supply and demand for currency.

-An increase in the supply of a currency will decrease the exchange rate of a currency.

-A decrease in supply of a currency will increase the exchange rate.

-An increase in demand of a currency will increase the exchange rate of a currency.

-A decrease in demand of a currency will decrease the exchange rate of a currency.

Appreciation and Depreciation 

-Appreciation of a currency occurs when the exchange rate of that currency increases.

-Depreciation of a currency occurs when the exchange rate of that currency decreases.

Exchange rate determinants 

Consumer tastes 

Relative income 

Relative price level

Speculation 

Exports and imports 

-The exchange rate is a determinant of both exports and imports.

-Appreciation of the dollar causes American goods to be relatively cheaper thus reducing exports and increasing imports.

-Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be more expensive thus increasing exports and reducing imports.