IB Econ Study Guide Internationals - Sunny Hills High School

The terms strictly refer to offlc,a/ changes in the price (the
value) of a currency in a f,ixed exchange rate system.
More specifically, a currency devalues if its official price
decreases within a fixed exchange rate system. A currency
revalues if its official Drice increases within a fixed
exchanoe rate svstem.
Let us see how to properly label ihe axes in a foreign
exchange diagram. Assume that we are interested in the
euro market and that you are focusing on the price of the
euro.
on the vertical axis write 'price of euro'. Then write on
the horizontal 'euros traded oer oeriod'.
Lastly return back to the vertical and write 'expressed in
dollars, $/€'.
To avoid errors think of the market for. say, onions instead
of the market for euros, in which case the vertical axis
would read 'price of a kg of onions, expressed in dollars'
while the horizontal would read 'quantity of onions
traded Der oeriod'.
l\4ore generally, the price of whatever currency you have
on the vertical will {eature on the horizontal as well as in
the denominator of the currencies fraction, as in Fig. 4.8a.
Since the vertical axis is the price of a euro it follows that
the demand curve will be the demand for euros and that
the supply curve will be the supply of euros (Fig, 4,8a).
Figure 4.8a Labelling a foreign exchange market diagram
:*d
.E Sc
a -9 -g E
$1.4s
(or, el)
Euros traded per period
. For example in January 2002 the Argentine peso
went from P 1.00 = $1.00 to P 1.40 = $1.00. This is a
devaluation of the peso or, equivalently, a revaluation of
the dollar A dollar could have been bought using one
peso but after the devaluation one needed 1.4 pesos to
buy a dollar.
The mirror image is:
Remember that a trader who is buying euros is at the
same time selling dollars and if she is selling euros she is
buying dollars.
Remember also that if the dollar price of the euro is e/,
then the euro price of the dollar is the inverse i.e. (1/e7).
Using December 2007 figures, since the dollar price of
the euro was 1.45, then the euro price of the dollar was
(1/1 .45) = o.69. On the diagram (Fig. 4.8b) you would
write on the vertical axis 'price of dollar', then go to the
horizontal axis and write 'dollars traded oer Deriod' and
lastly, return to the vertical axis to write 'expressed in
euros, €/$'. The demand would be demand for dollars,
the supply would be supply of dollars and the exchange
rate would be euros 0.69 (or]/e7).
Figure 4.8b Labelling a foreign exchange market diagram
ir-
:fe
ogf,
#sp
euros
0.69
{o[ 1/e1)
s ol dolla15
Dollars traded p€r poriod