11.5 Exchange Rates

Notes

The exchange rate is the price of one currency in terms of another, such as 1 U.S. dollar = 0.90 euro.

• To convert foreign prices to dollars, divide by the number of foreign units per dollar. Worked example: at 1 dollar = 0.90 euro, a 45-euro item costs $\displaystyle \frac{45}{0.90} = 50$ dollars.
• Most major currencies have floating exchange rates set by supply and demand in foreign exchange markets. Some countries fix (peg) their currency to another. The Bretton Woods system of fixed rates (1944) ended in the early 1970s.
• A currency appreciates when it buys more of other currencies. A strong dollar makes imports cheaper for Americans and U.S. exports more expensive for foreigners.
• A currency depreciates when it buys less of other currencies. A weak dollar makes U.S. exports cheaper abroad and imports more expensive at home.
• Worked example: the rate changes from 1 dollar = 100 yen to 1 dollar = 120 yen. The dollar appreciated. A 6,000-yen item that cost $\displaystyle \frac{6{,}000}{100} = 60$ dollars now costs $\displaystyle \frac{6{,}000}{120} = 50$ dollars.