Question

The exchange rate between the U.S. dollar and other currencies has gone through wide fluctuations in recent years. Use an example of a foreign currency (e.g., Mexican peso, British pound, etc.) and discuss how it has changed in price relative to the U.S. dollar over the past two to three years. Analyze how exchange rates affect domestic economic activity, including the supply and demand factors that moved the relative prices.

Answer 1

Over the past 2-3 years, the value of British Pound has shown very high fluctuations with respect to the US dollar.

It was 1.4 in 2016, 1.1 in 2017, 1.42 in 2018 and is $1.31 currently.

Exchange rates have a large impactcon economic activities as it changes prices of foreign goods and heavily affects demand for domestic goods in foreign markets. This then affects imports and exports.

When a currency appreciates (when it's value increases with respect to foreign currency), imports become cheaper while exports become costly. This increases demand for foreign goods, thereby leading to an increase in imports, and thus net exports falls, and so thus GDP

When a currency depreciates, exports become cheaper while imports become expensive. This reduces demand for foreign made goods and increases demand for domestic goods. This then leads to an increase in net exports and hence GDP