6.3 Foreign Exchange Market

Foreign exchange demand is the quantity of an international currency that all domestic and foreign currencies are willing and able to purchase at various rates of exchange.

The relationship between exchange rates and the quantity of currency demanded is inverse:

💡As the exchange rate rises, domestic and foreign consumers will purchase less quantity of the currency.

💡As the exchange rate falls, domestic and foreign consumers will purchase more quantity of the currency.

Foreign exchange supply is the quantity of an international currency that all domestic and foreign sellers are willing and able to sell at various rates of exchange.

The relationship between exchange rates and quantity of currency supplied is positive or direct:

💡As exchange rates rise, domestic and foreign consumers are willing to sell more.

💡As exchange rates fall, domestic and foreign consumers are willing to sell less.

Equilibrium is achieved in the FOREX Market (the market in which foreign currency is bought and sold) when the quantity supplied of the currency equals the quantity demanded of the currency at a specific exchange rate.

Let's draw the FOREX Market in Equilibrium for the EURO (💶) relative to the U.S. Dollar (💵):

Since in the FOREX market we are working with has flexible exchange rates, the exchange rates are constantly changing. When they rise above equilibrium or fall below equilibrium, the market will force them back up to equilibrium.