Pounds sterling, Swiss francs, the Euro, or any other freely convertible currency (FCC)

The downsloping demand for pounds, FCC shown by DD(Figure 9.1) indicates that, if pounds

Become less expensive to Americans, imported goods will become cheaper in the US. This fact

Appreciation

C r i t i c a l

E y e.

Causes Americans to demand larger quantities of imported goods and therefore larger amounts of

Pounds and FCC with which to buy those goods.

The supply of pounds and other FCC is falling, as shown by SS, because, as the dollar price of

pounds, other FCC rises (that is, the pound price of dollars falls), the Europeans will be inclined to

Purchase more American goods. The reason, of course, is that at higher and higher dollar prices for

Pounds and other FCC, the Europeans can get more American dollars and therefore more American

Goods per pound, FCC. Thus, American goods become cheaper to the Europeans, inducing

Them to buy more American goods. When buying these goods, they supply pounds and other FCC

to the foreign exchange market because they must exchange pounds and FCC for dollars to purchase'American

Goods.

The intersection of the supply and demand for pounds will determine the dollar price of pounds

and other FCC. In this instance the equilibrium rate of exchange is $1.5 to ￡1.0.

Figure 9.1. The market for foreign exchange

Depreciation and appreciation. An exchange rate which is determined by free-market forces can