Wize AP Macroeconomics Textbook > Macroeconomic Theory of the Small Open Economy
Supply and Demand of Foreign Currency
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Net Capital Outflow and Supply and Demand of Foreign Currency
Affect of Interest Rates on Exchange Rates
- The supply of dollars - this is the supply of our domestic dollars available to other countries. It is the net capital outflow.
- The demand for dollars - this is how much domestic dollars foreign countries are demanding. It comes from our net exports. As demand for our exports increase that means other countries will demand more of our domestic dollars to buy those goods.
Factors that Affect the Exchange Rate
1. Increase in world interest rate - this will cause a
bigger
NCO and the supply of dollars to shift right
. The dollar will depreciate
and next exports will increase
2. Government deficit - this will cause national savings and supply of loanable funds to
decrease
. The NCO will be smaller
and so the supply of dollars shifts left
. The dollar will appreciate
and net exports will decrease
3. Import Quotas/Tariffs
