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Exercise: foreign exchange market

  •  You are given the following demand and supply schedules for the U.S foreign exchange market for Mexican pesos:

  • Identify the equilibrium exchange rate and quantity, and draw the demand and supply curves. Then, what would happen to the value of the pesos if the demand for American goods increases? What should we expect to happen to the U.S current account? Assuming the trade balance is by far the biggest variable and the U.S 's current account was equal to 0 before this sudden increase.
    • The equilibrium must be the point that is shared by both the demand and supply schedules. Thus, one pesos is worth about 0.5 U.S dollars (the exchange rate) and there are 6,250,000 pesos supplied at this point, assuming that one p is worth 10 million pesos.
    • Let's graph the demand and supply curves:

    • If the consumers in Mexico want to consume more American goods, then we should expect the supply curve for pesos to shift to the right. This will cause an appreciation of the dollar and depreciation of the pesos. 

    • Note that from the graph we see that one peso is worth less dollars than before.
    • The current account should be at a surplus, since now more U.S goods are consumed abroad. Though the appreciation of the U.S dollar should slowly decrease the the U.S current account certeris paribus.


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Location: Boston, MA, USA

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