Exchange Rates

EXCHANGE RATES
An exchange rate is the price of one currency measured in terms of other

currencies.
For example,
the exchange rate of the US Dollar in terms of the Rupiah might be
US$1 = Rp15.000,-
When a student spends US$2 to pay 1 import novel from the US it means this
student Rp30.000,-
The Importance of exchange rates
Different countries use different forms of money, exchange rates are fundamental in
facilitating international trade.
INDONESIA USA
Money inflow results the appreciation of exchange rates and money outflow
results the depreciation of exchange rates.
Floating Exchange Rates
In the floating exchange rate system, the value of a currency is determined by the market
forces of supply and demand for the currency.
Causes of appreciation of exchange rates Causes of depreciation of exchange rates
Fixed Exchange Rates
In the fixed exchange rate system, the value of a currency is determined by the government
intervention.
Causes of exchange rate fluctuations
- Changes in demand for exports – an increase demand for exports will increase demand for country’s
currency. Therefore, this increases the exchange rate.
- Changes in demand for imports – an increase in the demand for imports will raise demand for the foreign
currency. Therefore, this decreases the exchange rate.
- Price and inflation – an increase in the price of goods and services will tend to decrease the demand for
exports. This will therefore cause the exchange rate to fall in value.
- Foreign direct investment – when a multinational company expand to one country, open factory and
distribute the product in that country, this company needs much domestic currency to pay the workers. And
it would increase demand for domestic currency and increase the exchange rate.
- Speculation – foreign exchange traders and investment companies move money around to seek higher
interest rates (hot money). This can cause sudden fluctuation in the short run and depreciates the exchange
rate when the investors withdraw their investment.
- Government Intervention (fixed exchange rate) – Government intervention in the foreign exchange market
can affect the exchange rate. For example, when demand of dollar increase, government can sell its dollar
reserves (by buying back government bond) and it would increase supply of dollar and lead to a fall in the
value of its currency.
Consequences of exchange rate fluctuations
- Customers – when the exchange rate increases, customers will have greater purchasing power including
import products
- Exporters – exporters face more difficult trading conditions when the exchange rate increases because
export products will be more expensive and people won’t buy them much due to higher prices.
- Importers – imports potentially cheaper due to stronger domestic currency face against foreign currency.
- Balance of Payments – the appreciation of exchange rate results a fall in the value of exports, then the BOP
will worsen. A strong currency will make exporters more difficult to sell their products in overseas markets.
- Employment – a fall in net exports and profits in the long run causes job losses and unemployment rate tend
to increase in the economy.
- Inflation – Lower level of spending caused by higher unemployment will tend to reduce the rate of inflation.
- Economic growth – In the long run, higher unemployment rates and lower export sales result a fall in
economic growth in the long run.
Coping with a strong exchange rate
- cutting export prices to maintain their price competitiveness against foreign rivals even though domestic
firms will have to accept lower profit margins.
- seeking alternative overseas suppliers of cheaper raw materials and components.
- improving efficiency by increase productivity (economies of scale)
- focusing on supplying more price inelastic products because customers become less sensitive to exchange
rate fluctuations.
- focusing on non-price factors that are important to overseas customers such as brand awareness and social
responsibility.
- relocating production process overseas where costs of production are relatively low and where operations
are less exposed to exchange rate fluctuations.
For example, the exchange rate of the US dollar in terms of the Hongkong
Dollar might be $1.25 = HKD100. It means that a Hongkong tourist
spending $500 on hotel accommodation in the USA would have spent the
equivalent of HKD 1_________. If the US Dollar fell against HKD to 1.40 =
HKD100 then the Hongkong tourist would pay 2 ______________for
staying at the hotel in the USA. Looking this from the perspective of
Hongkong, the 3_____________(increase/decrease) in its exchange rates
means that import will be 4____________ (more expensive/cheaper) and
export will be 5_________ (more expensive/cheaper).
If the exchange rate of the US dollar in terms of the Yen, it might be
US$1.25 = JPY100. It means that a Japan tourist spending $400 on
hotel accommodation in the USA would have spent
the equivalent of JPY 1__32.000________.
If the US Dollar rise against US$ to 0.80 = JPY100 then the Japan
tourist would pay 2 ____50,000__________for staying at the hotel in
the USA. Looking this from the perspective of USA, the
3_increase_(increase/decrease) in its exchange
rates means that import will be cheaper and export will be 4_more
expensive__ (more expensive/cheaper). However, an increase in
number of tourists would affect Dollar to be more
5_appreciate__(appreciate/depreciate)

Exchange Rates

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EXCHANGE RATES

An exchange rate is the price of one currency measured in terms of other

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