Understanding Foreign Exchange Rate and its Determinants: An Analysis of AUD/USD Exchange Rate

Running head: ECONOMICS ASSIGNMENT
Economics assignment
Name of the student:
Name of the University:
Author note

1ECONOMICS ASSIGNMENT
Table of Contents
Answer a:.........................................................................................................................................2
Answer b:.........................................................................................................................................3
Answer c:.........................................................................................................................................5
Answer d:.........................................................................................................................................7
Answer e:.........................................................................................................................................8
Reference:......................................................................................................................................11

2ECONOMICS ASSIGNMENT
Answer a:
With rise in the international trade, economies around the world are indulging itself into
higher amount of trade. With rise in the international trade, it has become essential for the
economies to calculate the value of their currency with respect to their currency. Foreign
exchange rate of a nation refers to the monetary valuation of the country’s domestic currency
with respect to the other currency value of other nation (Edwards 2015). Predicting foreign
exchange rate is hard, however utilising simple supply and demand model, it can easily be
explained.
Figure 1: Exchange rate determination with supply and demand model
Source: (Created by Author)
Considering the figure 1, it can be seen that there is demand and supply curve, which are
being drawn depending upon the perceived demand of the AUD and the aggregate supply of
AUD respectively (McNamara et al. 2016). Initial equilibrium occurs at point E, where the

3ECONOMICS ASSIGNMENT
exchange rate is Ex0 and the demand of AUD is Q0. Now, if there is rise in the demand of the
AUD in US market, then it will shift the demand curve from D0 to D1 and the new equilibrium
occurs at E1, where the exchange rate is EX1 and demand of AUD is Q1. On the other hand if the
demand of AUD falls from Q0 to Q2, then it will shift the demand curve to D2, position causing
newer equilibrium at E2, where the exchange rate is EX2. Thus through demand and supply
model, exchange rate can easily get determined.
Now, considering this it can be said that supply and demand model of foreign exchange
can easily explain the various factor that affect the AUD in the foreign exchange market.
Following are the essential influencer of the AUD/USD exchange rate:
Interest rate – change in interest rate will change the foreign investment, which can alter
the demand of AUD (Johnson 2017). With change in demand of AUD, exchange rate of
AUD/USD will also change.
Inflation – higher inflation can lead to depreciation of the AUD/USD exchange rate and
the lower inflation can cause better investment prospect leading to currency appreciation
on behalf of the AUD (Guofeng 2015).
Government policies – if government takes expansionary fiscal or monetary policy or if
it can take export promotion polices along with import substitution, then it will help to
influence the demand of the AUD, leading to appreciation of the AUD in terms of USD
(Melvin and Norrbin 2017).
Answer b:
Nominal exchange rate is the number of domestic currency required to attain one unit of
foreign currency (Eichenbaum et al. 2017). According to the same source, with rise in nominal
exchange rate of a domestic currency, purchasing power of the domestic population gets