Causes of shifts in currency supply and demand curves | AP Macroeconomics | Khan Academy

Talk a little bit about what could cause the supply or demand curve for a currency to shift.

So here we have the foreign exchange market for the Chinese yuan, which is why we have the quantity of one on the horizontal axis and the price of one in terms of another currency on the vertical axis. And here, that other currency is the U.S. dollar. Associated with this, let’s just call this S sub 1 our supply curve and D sub 1 our demand curve. You have at the intersection an equilibrium point. We have talked about this in other videos; let’s call that E sub 1. This would be some dollar price for a yuan; maybe it's 10 U.S. cents per one.

And then associated with that, there is also an equilibrium quantity, Q sub 1. That would be a certain amount of yuan that is trading hands in a certain time period, whatever the time period this model applies to.

So one big way to think about what would influence supply and demand is to think about who holds the supply and then who is demanding that currency. If we think about the market for the Chinese yuan, the supply is going to be from people who hold yuan—people who hold yuan, and for the most part, that's going to be people in the country.

It's possible that someone sitting in New York has a yuan-denominated account or has some yuan sitting in their wallet, but for the most part, it’s going to be people in the country, so motivated primarily by what happens in China. On the other hand, if we’re thinking about demand, it’s the other way around. These would be other people that, for some reason, want to convert their currency, their non-yuan currency, into the yuan.

So, people who hold other currencies—other currencies like the U.S. dollars—and this tends to be motivated. It’s possible that someone in Beijing is holding dollars or has a dollar bank account, but for the most part, it’s going to be motivated by other countries.

For example, if we think about supply, what could shift the supply to the right or could increase supply? Shifting the supply means more Chinese want to sell their yuan; they want to convert it into something else, let’s say U.S. dollars. This could be an increase in demand; we could say demand for foreign goods, services, or assets.

In this case, it might be an increase in demand for American goods, services, or assets. They might want American assets because they get a better return there or maybe they view them as safer investments. Maybe they want to send their children to an American college, so there’s a demand or there’s an increase in demand for sending kids to American colleges.

That’s a service. Maybe they are interested in buying more American cars. Another thing that could increase the demand for, say, American goods is if there’s a decrease in tariffs on those things, so those things have become cheaper in China.

Any of these things could shift the supply curve to the right; this is S sub 2. Associated with that, we would have a new equilibrium exchange rate, E sub 2, and a new equilibrium quantity that is changing hands. Notice the price of the yuan has now gone down as people are demanding, in this case, more American goods.

Of course, if we switch the arrows here, if we had a lower demand for, let’s say, American goods, services and assets, then the supply curve would shift to the left, and the yuan would become more expensive in terms of dollars.

And so on the demand side, it works the other way around. What could shift the demand curve to the right? Let’s say this is D; let’s call this D3. Right over here, let’s assume that the supply curve has not been shifted, so this would go to E sub 3.

So the yuan has become more expensive, and that makes sense; more people are demanding it, and we have a different quantity now. Let’s call that Q sub 3. But what would cause it to shift in that way?

So demand for yuan would go up if you have an increase in demand for Chinese goods from foreigners—Chinese goods, actually I should say services, or assets. If you have an increase in the number of Americans who are holding dollars and saying, “Hey, I could get a better return if I invest in China; maybe it's growing faster,” so I want to convert my dollars into yuan.

I want to buy yuan with my dollars so that I could buy, so I could participate in the Chinese stock market or buy shares or somehow buy some Chinese real estate or whatever else it might be. Obviously, if demand for Chinese goods, services, and assets were to go down, then the demand curve would shift the other way.