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How do exchange rates work?

Posted on January 17, 2015 at 11:20 AM

An exchange rate is determined by supply and demand in the foreign exchange market. It is how much of one country’s currency it takes to buy one unit of another country’s currency.

For example, it might cost 0.73 euro to buy $1 US this month. If it costs 0.5 euro to buy $1 US next month, the euro has appreciated in value because it takes fewer euros to buy $1 US. This means that the dollar has depreciated against the euro.

With the exchange rates from the example above, $1.37 US will buy 1 euro this month. Next month, it costs $2 US to buy 1 euro. Again, the euro appreciated and the US dollar depreciated. Exchange rates and the value of a currency are all relative.

AP Macroeconomics Unit 6 International Trade

Categories: AP Macroeconomics, Macro Unit 6 International Trade

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