• Size of FX market:

• Type of FX market/location:

• ______% of all foreign exchange trading takes place in London, New York

and Tokyo. Another ______ % takes place in Zurich, Singapore and Hong Kong

More specifically, in 1998 $ _______ billion of daily FX trading took place

in London, billion in New York, and $ ______ billion in Tokyo.

• Historical determination of FX rates:

• Current determination of FX rates:

4. Export supply:

5. Import demand:

7. Inelastic:

• Normally a currency depreciation (appreciation) will ________terms of trade.

A. Currency Supply

*The supply curve of a currency is derived from:

*Thus, the supply of currency = value of imports.

*Shifts in the currency supply curve occur due to:

Elastic Currency Supply

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Inelastic Currency Supply

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B. Currency Demand

*The demand curve of a currency is derived from:

*Thus the demand for a currency = value of exports.

*Shifts in the currency demand curve occur due to:

Elastic Currency Demand

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Inelastic Currency Demand

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• The equilibrium exchange rate is the one that equates the value of ______ with the value of ______.

• Downward sloping currency supply curves:

• When a currency demand curve is more ________ supply curve, exchange rates are unstable. For example:

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C. Review Ouestions

1. Is it possible for a country to run a large BOT deficit without experiencing a real depreciation of its currency?

2. What is the effect of a country's currency appreciation on the BOT when the currency demand curve is more inelastic than the currency supply curve?

3. What is the effect of a country's currency appreciation on the BOT when the currency demand curve is more elastic than the currency supply curve?

4. What is the effect of a country's currency depreciation on the BOT when the currency supply curve is more inelastic than the currency demand curve?

5. What is the effect of a country's currency depreciation on the BOT when the currency supply curve is more elastic than the currency demand curve?

6. If import demand is inelastic and a currency appreciation occurs what

is the effect on the BOT?

7. Will a currency appreciation always result in a decrease in the BOT and will a currency depreciation always result in an increase in the BOT?

The J-Curve

• The J-Curve theory of the BOT states that in the short-run import demand is ___________ while in the long-run import demand is ___________ (Note: in both countries this is true).

(a) Currency Appreciation

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(b) Currency Depreciation

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