16 Sep 2022


Analyzing the Exchange Rates Concept

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Academic level: College

Paper type: Research Paper

Words: 897

Pages: 3

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Part 1

Currency exchange rates refer to a county’s money value as compared to another (Lim & Ogaki, 2013) . In this case, different currencies’ value is influenced by the countries economies strength. This strength can be measured by several factors such as inflation, a country’s interest rates as well as confidence in the government. For instance, if a country lacks a stable government or has high inflation, its currency’s value ought to decrease. 

The currency exchange rates express the extent to which a currency’s single unit should be exchanged for a different currency (Sobel, 2013) . In addition to this, the currency exchange rates can either be floating or pegged (fixed) to a different currency. Floating currency exchange rates change from time to time depending on various factors. On the other hand, fixed or pegged currency exchange rates shift in tandem with the specific currency that is pegged to it (Sobel, 2013)

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Understanding the value of the currency of your country as compared to other foreign currencies enables investors when analyzing investments quoted in foreign dollars (Sobel, 2013) . For instance, for an investor in U.S., understanding the dollar to euro rate of exchange is necessary when choosing European investments. A decreasing U.S. dollar leads to a rise in the value of the foreign investment; a rise in the value of the United States' dollar leads to a decline in the value of the foreign investment. 

Pursuing this further, the floating exchange rates are dependent on demand and supply market forces. In that, the level of demand, as it corresponds to supply of currency, determines the value of that currency as it corresponds to a different currency (Lim & Ogaki, 2013) . In this case, with an increase in the U.S. dollar demand by European countries, the relationship of demand-supply leads to a rise in the U.S. dollar price when compared to the euro. Additionally, many economic and geopolitical declarations that influence the rates of currency exchange between two nations such as unemployment rates, interest rates decisions, manufacturing information, inflation reports as well as the numbers of the gross domestic product. 

Some nations might opt using a fixed rate of exchange that the government maintains and sets artificially. Such an exchange rate does not fluctuate intraday as it is reset on certain dates (revaluation dates). Thus, emerging market countries governments often apply this strategy to ensure their currencies value is stable. On the same note, a country’s government holds large currency reserves that peg its currency, for controlling changes in demand and supply, to ensure the stability of the fixed foreign exchange rate (Lim & Ogaki, 2013)

The purchasing power parity 

The purchasing power parity compares the change in the supposed inflation rates between two countries to their currency exchange rates change. In that, inflation minimizes the actual purchasing power of the currency of a country (Reis et al., 2010) . Therefore, if a nation has a 10% annual inflation rate, then its currency will have the capacity of purchasing 10% less real annual goods. In other words, the purchasing power parity determines the price levels change between two nations as well as ensures that rates of exchange change to compensate for the differentials of inflation. 

The principle of purchasing power parity as well applies to the assets real returns earned by different international investors. It assumes that the return’s real rate on assets has to be similar for all global investors (Sobel, 2013) . For instance, Mexico’s financial asset has a 10% annual return rate in Mexican pesos. Assuming that Mexico has a 4% annual rate of inflation, the United States has a 2% annual rate of inflation and that their annual dollar appreciation rate is 2% as expected by the purchasing power parity. Approximately, investors in the U.S. annually earn around 8% in relation to Mexican pesos. As a result of this, their annual return’s real rate would be about 6% after considering the U.S. inflation. This resembles what the investors in Mexico earn, around 6%. So, every investor gets a similar return’s real rate on certain assets. Nevertheless, the purchasing power parity concept is theoretical and might not be true, particularly in the short run, in the real world. 

Part 2 

Why a quota is more detrimental to an economy than a tariff that results in the same level of imports as quota 

The government's revenue is generated by tariffs (Lim & Ogaki, 2013) . In this case, if the government of U.S. sets a 20% tariffs on foreign Indian cricket bat, they should collect 10 million dollars if 50 million dollars worth of cricket bats from are imported annually. Though this sounds like a slight government change, considering that different goods’ millions are imported from other nations, these numbers start adding up. This revenue might be lost to the government. Hence, their system of import quota changes all importers a licensing fee. 

In addition to this, administrative corruption might result from import quotas (Sobel, 2013) . Assume that currently not restriction is based on foreign cricket bats from India and 30000 are annually sold in the U.S. Due to some circumstances, U.S. opts just to want an annual sale of 5000 cricket bats. To meet this objective, they should set a 5000 import quota. However, deciding which 5000 cricket bats enter the country become a major problem. Therefore, the government should allow some investors to import bats while preventing others from doing the same. By so doing, the customs official gain much power since they can allow importation to their favored corporations while denying importation access to the unlucky parties. This might result in critical problems linked to corruption in nations having import quotas because the investors chosen for meeting the quota are those who can offer the customs officers the best favors. 

Finally, without corruption possibility, tariff systems can meet the same objective. The tariff is estimated at a level causing the cricket bats price to increase enough (Reis et al., 2010) . As a result of this, the bats' demand reduces to 5000 each year. Though a good’s price is controlled by tariffs, they indirectly regulate the amount sold of the good due to the demand and supply interaction. Thus, tariffs are more preferred than import quotas. 


Lim, H., & Ogaki, M. (2013). A Theory of Exchange Rates and the Term Structure of Interest Rates.    Review Of Development Economics ,    17 (1), 74-87. http://dx.doi.org/10.1111/rode.12016 

Reis, J., Farole, T., Wagle, S., & Reis, J. (2010).    Analyzing Trade Competitiveness   (1st ed.). Washington, D.C.: The World Bank. 

Sobel, A. (2013).    International political economy in context   (1st ed.). Thousand Oaks, Calif.: CQ Press. 

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StudyBounty. (2023, September 14). Analyzing the Exchange Rates Concept.


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