Question

Suppose that the exchange rate for the Mexican peso fell from 15 pesos per U.S. dollar to 10 pesos per U.S. dollar. What is the effect of this change on the quantity of U.S. dollars that people plan to buy in the foreign exchange market?

Short answer

The quantity of U.S. dollars that people plan to buy will increase.

Step-by-step solution

Understanding the initial and final exchange rates

Initially, the exchange rate is 15 pesos per U.S. dollar. After the change, the exchange rate falls to 10 pesos per U.S. dollar.

Effect on the Mexican peso value

When the exchange rate falls from 15 pesos to 10 pesos per U.S. dollar, the value of the Mexican peso has increased. Each peso can now buy more U.S dollars than before.

Effect on demand for U.S. dollars

With the peso's increased value, it is cheaper for people holding pesos to buy U.S. dollars. Consequently, the quantity of U.S. dollars that people in Mexico plan to buy will increase.

Key concepts

Exchange Rate

Exchange rate refers to how much one currency is worth compared to another. In the given exercise, we see the exchange rate change for the Mexican peso against the U.S. dollar. Initially, the exchange rate is 15 pesos for every U.S. dollar. After the change, it drops to 10 pesos per dollar. This means that fewer pesos are needed to buy one dollar. Exchange rates can fluctuate based on various factors like economic stability, interest rates, and market speculation. These rates are essential because they influence international trade and investments. They can affect how expensive it is to buy goods from another country or how costly it is for foreign tourists to travel.

Currency Value

Currency value is a measure of how much one country's money is worth in terms of another country's money. When the value of the Mexican peso rises, you need fewer pesos to buy the same amount of U.S. dollars. For example, if the rate changes from 15 pesos per dollar to 10 pesos per dollar, each peso is worth more. Higher currency value can be a sign of a stronger economy or favorable economic conditions. However, it might also be influenced by governmental policies or external factors like market demand. When the peso value increases, it can make imported goods cheaper for people in Mexico. This can lead to more purchasing power and economic benefits.

Demand for Foreign Currency

The demand for foreign currency refers to how much people want to buy currencies from other countries. In this exercise, we focus on the demand for U.S. dollars in Mexico. When the value of the Mexican peso increases from needing 15 pesos to 10 pesos per dollar, it becomes cheaper for people to buy U.S. dollars. As a result, the quantity of U.S. dollars that people plan to buy increases. High demand for foreign currency can be driven by various needs, such as traveling, investing, or paying for imports. If a country’s currency strengthens, it usually boosts the demand for foreign currencies, leading to more international transactions and economic activity.