Question

suppose the equilibrium exchange rate for dollars to euros is 1.2 representing 2 billion dollars traded, and the German consumers have recently started buying the latest iPads. Explain using graphical analysis what would you expect to happen to the equilibrium quantity and price in the currency market?

Answer 1

1 euro is currently being traded for $1.2. That means the price of one dollar is 1/1.2 or 0.82 euros. Below is a supply and demand curve for dollars in the euro dollar exchange market.

The initial supply and demand curves are represented as AS and AD respectively. The equilibrium E represents the given exchange rate and quantity of dollar traded.

As German consumers start demanding more iPads, the demand for dollar increases. This is because in order to import iPads, German importers will need to buy dollars. This shifts the demand curve to the right to its new position AD'. This represents a new equilibrium points where dollar is more expensive and a higher quantity of dollar is traded.