The demand curve for foreign currency slopes downward because?
a. the quantity supplied of the foreign currency rises as the exchange rate falls.
b. at lower exchange rates, foreign goods look cheaper to home country residents.
c. marginal utility theory says that individuals substitute into any commodity whose price has fallen.
d. at higher exchange rates, the home currency can buy more foreign goods.
The correct answer and explanation is:
The correct answer is b. at lower exchange rates, foreign goods look cheaper to home country residents.
The demand curve for foreign currency slopes downward due to the inverse relationship between exchange rates and the demand for foreign goods and services. The key idea here is that when the exchange rate falls, meaning that the home currency appreciates relative to foreign currencies, the cost of foreign goods and services becomes lower for the residents of the home country.
This creates an incentive for home country residents to purchase more foreign goods and services. As the exchange rate decreases, foreign goods become cheaper, and consumers are more likely to buy them. The demand for foreign currency, which is needed to purchase these goods, increases as a result. In essence, a lower exchange rate makes foreign products more affordable, which leads to a higher demand for foreign currency to facilitate these transactions.
Additionally, from a broader economic perspective, when the exchange rate falls, it increases the purchasing power of the home currency abroad. This encourages residents to engage in more international trade by importing more goods and services from foreign countries, which in turn increases the demand for foreign currency.
Therefore, the demand curve for foreign currency slopes downward because as the exchange rate decreases (or the home currency appreciates), foreign goods and services become cheaper for home country residents, leading to an increase in demand for foreign currency. This reflects the standard economic principle of substitution, where consumers tend to buy more of what becomes relatively cheaper.