As defined by its name, an open economy is essentially “open” to trade. With limited barriers, most goods can be traded intra- and internationally. Yet the world’s economy is ambiguous, mysterious, and, in fact, unpredictable; studies in macroeconomics have established trends and analyses that could explain the basics of international trade and the flow of a country's currency.
Exchange rates and the foreign exchange market
In countries with a functioning economy, their trusted currency exists as a term of trade in the international currency market, which allows different currencies to perform trades with each other (currency exchange). This market functions for 3 main reasons:
International citizens want to trade commodities across countries.
The need for localized currency by Foreign Investments
Monetary Gifts and transactions by International citizens. (Travel, sending money internationally).
Holding the quality of “a medium of exchange” in Fiat Moneys, there exists supply and demand relationships with every 2 currencies in the foreign exchange market.
And also holding the quality of “a store of value”, currencies' value fluctuates based on their demand and supply, which economists define as appreciation and depreciation. The appreciation and depreciation of value are also what we call the change in the exchange rate, which is measured by the equilibrium point of the S and D graph. For example, when the demand for US dollars increases, US dollars appreciate due to higher competition in its trade, which leads to more amounts of other currencies trading for the same amount of USD and vice versa for a decrease in Demand.
Factors causing the change in currency:
Impacts on Income levels
Income Levels directly relate to the demand for goods from one country to another, as your purchasing power will proportionally change with a change in salary.
Changes in Inflation rates
When Inflation increases in a country, the general price of goods may be relatively more expensive than other competitors, which decreases the international demand for that country's goods, and vice versa when inflation decreases. However, the elasticity of demand for specific products (e.g., oil, silicon chips) may also affect demand.
Changes in Consumer Preferences of goods in a country.
If a country's goods are known for being cheaper or of better quality, then the demand for its currency proportionally increases.
Impacts on national confidence.
When economic activities are stable and booming, investors may be attracted to further investment and vice versa with unstable economies due to conflicts or recession.
Government Policies
Governments can directly influence the demand for goods between countries through various policies, including tariffs, import bans, and even wars.
Reference list
courses.lumenlearning.com. (n.d.). Demand and Supply Shifts in Foreign Exchange Markets | Macroeconomics. [online] Available at: https://courses.lumenlearning.com/wm-macroeconomics/chapter/demand-and-supply-shifts-in-foreign-exchange-markets/.
Reed, J. (2021). How to Understand The Foreign Exchange Graph. [online] ReviewEcon.com. Available at: https://www.reviewecon.com/foreign-exchange.
Segal, T. (2023). Learn More About the Concept of an Open Market. [online] Investopedia. Available at: https://www.investopedia.com/terms/o/open-market.asp#:~:text=Key%20Takeaways-.
Comments