Foreign Exchange Market (USD) graph mistakes

15 ways students lose points on this diagram, each taken from a worked free-response scenario. Every entry names the reasoning that causes the error, not just the error, because the wrong answer is usually a sensible thought applied to the wrong curve.

1. 01

   Interest Rate Differential

   The mistake. A frequent wrong answer is shifting the supply of dollars left, on the idea that capital flowing into the United States pulls dollars out of circulation. British investors are not selling dollars, they are buying them, so the only side of this market that changes is the foreign side that must acquire dollars first.

   Draw this instead. Demand for dollars (D$) shifts right.

   Exam tip. When an interest rate moves in the country whose currency the graph measures, ask whose assets just became more attractive. Foreigners buying US assets is always a D$ shift, never an S$ shift.

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2. 02

   Appetite for Imports

   The mistake. Students often shift the demand for dollars right because Americans are described as demanding more of something. What Americans demand here is Korean goods, which forces them to demand won and supply dollars; the D$ curve tracks foreigners wanting dollars, not Americans wanting products.

   Draw this instead. Supply of dollars (S$) shifts right.

   Exam tip. Rewrite every FX stem as "who must convert which currency." US buyers of imports have to sell dollars, so more imports means S$ right and a weaker dollar.

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3. 03

   Recession Abroad

   The mistake. The most common wrong answer is shifting the supply of dollars left, on the reasoning that fewer US exports means fewer dollars changing hands. US exports are paid for by foreigners who must buy dollars first, so a drop in exports is a decrease in the demand for dollars; S$ tracks Americans selling dollars, and nothing here changed what Americans buy abroad.

   Draw this instead. Demand for dollars (D$) shifts left.

   Exam tip. Foreign income is a determinant of D$ and domestic income is a determinant of S$. A recession abroad cuts US exports and shifts D$ left, while a recession at home cuts US imports and shifts S$ left, and the two move the exchange rate in opposite directions.

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4. 04

   Tourism Boom to the US

   The mistake. Many students shift the supply of dollars because the visitors are described as spending money inside the United States. Those visitors have to buy dollars with Marovian currency before they can spend anything, and anyone acquiring dollars belongs on the demand side of this graph.

   Draw this instead. Demand for dollars (D$) shifts right.

   Exam tip. Treat inbound tourism as a US export of services: foreigners buying anything American, a good or a hotel night, shifts D$ right and appreciates the dollar.

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5. 05

   Americans Vacation Abroad

   The mistake. The usual error is shifting the demand for dollars right because the tourists are spending dollars and the graph is labeled the market for dollars. Spending dollars in Selvenia means selling them for Selvenian currency, which puts more dollars onto the market and moves the supply curve.

   Draw this instead. Supply of dollars (S$) shifts right.

   Exam tip. Ask which currency the traveler needs once they land. US tourists abroad need foreign currency, so they supply dollars: S$ right and the dollar depreciates.

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6. 06

   US Central Bank Rate Cut

   The mistake. Students commonly shift the supply of dollars right, reasoning that an easing central bank increases the money supply so more dollars must reach the currency market. This graph tracks currency conversion, not the money supply; what actually changed is that foreign investors want fewer dollars, which is a leftward shift of demand for dollars.

   Draw this instead. Demand for dollars (D$) shifts left.

   Exam tip. Chain the money market to the FX market on multi-part FRQs: a policy rate cut lowers the return on US assets, foreigners buy fewer of them, D$ shifts left, and the dollar depreciates.

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7. 07

   Tariff on Imported Goods

   The mistake. The most common wrong answer is shifting the demand for dollars right, because Americans are now buying more US-made goods instead of Verdanian ones. An American buying an American good pays in dollars and converts no currency at all, so that substitution never touches this graph; the whole effect runs through Americans needing less Verdanian currency, which is a decrease in the supply of dollars.

   Draw this instead. Supply of dollars (S$) shifts left.

   Exam tip. For any tariff question, settle two things before you draw: who levied it, and on whose goods. A US tariff changes what Americans buy, so it moves S$; only a foreign tariff on US exports touches D$.

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8. 08

   Recession at Home

   The mistake. Students frequently shift the demand for dollars left, reasoning that a weak US economy makes the dollar less desirable. The stem holds foreign behavior constant, and a leftward demand shift would predict a depreciation, the opposite of what happens when Americans stop converting dollars into foreign currency.

   Draw this instead. Supply of dollars (S$) shifts left.

   Exam tip. Domestic income drives S$ and foreign income drives D$. Read which country the recession is in before you decide which curve to touch, because the two cases push the exchange rate in opposite directions.

   Try this one on a live graph
9. 09

   Retreat From Foreign Bonds

   The mistake. Because flight-to-safety stories usually end with foreigners piling into US assets, many students shift the demand for dollars right. Every actor described here is American, and Americans deciding not to convert dollars into foreign currency shows up as a decrease in the supply of dollars, not an increase in demand.

   Draw this instead. Supply of dollars (S$) shifts left.

   Exam tip. Underline the nationality of the buyer in the stem. Americans buying anything foreign, a good or a financial asset, always operate on the S$ side of this graph.

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10. 10

    Rising Remittances Home

    The mistake. Students often reach for the demand curve here, either shifting it right because a large sum of money is changing hands or shifting it left because dollars are leaving the country. Dollars leaving the United States this way are dollars being sold for foreign currency, and sellers of dollars are the supply side of the market.

    Draw this instead. Supply of dollars (S$) shifts right.

    Exam tip. Remittances, foreign aid, and any one-way transfer out of the United States behave exactly like imports on the FX graph: they put more dollars up for sale, so S$ shifts right and the dollar depreciates.

    Try this one on a live graph
11. 11

    Foreign Automaker Builds Plant

    The mistake. A common error is shifting the supply of dollars right on the logic that money is flowing into the United States, so there must be more dollars around. What flows in is Kessian currency, which is exchanged for dollars; the dollars are being bought rather than sold, which makes this a demand-side change.

    Draw this instead. Demand for dollars (D$) shifts right.

    Exam tip. Foreign direct investment into the US sits on the same side of the graph as foreigners buying US Treasury bonds. Both require foreigners to obtain dollars first, so both shift D$ right whether the investment is a factory or a financial asset.

    Try this one on a live graph
12. 12

    Foreign Tariff on US Goods

    The mistake. The most common wrong answer is shifting the supply of dollars left, because students memorize the US-tariff case as 'tariff means S$ left' and apply it without checking who imposed this one. Norhavn levied this tariff on American exports, so it changes what foreigners buy, and foreign buying is always the D$ side of the graph.

    Draw this instead. Demand for dollars (D$) shifts left.

    Exam tip. For tariffs, answer two questions before drawing: who imposed it, and on whose goods. A tariff that shrinks US exports moves D$ left; a tariff that shrinks US imports moves S$ left, and the two produce opposite exchange rate outcomes.

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13. 13

    Export Boom, Import Slump

    The mistake. The most common error is claiming both outcomes are determinate, usually writing that the dollar appreciates and the quantity of dollars traded falls because the drop in import buying is the change students notice first. Nothing in the stem says which shift is bigger, so only the exchange rate can be signed, and any confident claim about the quantity traded loses the point.

    Draw this instead. Demand for dollars (D$) shifts right and Supply of dollars (S$) shifts left.

    Exam tip. On a two-shift foreign exchange question, sign the exchange rate and the quantity separately: the variable both curves push the same way is your determinate answer, and write the word indeterminate for the other instead of guessing.

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14. 14

    Export Slump, Bonds Abroad

    The mistake. Students routinely report both outcomes as determinate, writing that the dollar depreciates and the quantity of dollars traded falls because a recession sounds like less of everything. The bond purchases push the quantity the other way, and with no information about the relative size of the two shifts the quantity traded cannot be signed at all. A second error is treating the pension funds as buyers of dollars, when buying a foreign bond requires selling dollars for foreign currency.

    Draw this instead. Demand for dollars (D$) shifts left and Supply of dollars (S$) shifts right.

    Exam tip. Draw the case twice, once with each shift as the larger one, and if the equilibrium quantity lands on opposite sides of its original level in the two drawings, write that it is indeterminate and name what it depends on.

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15. 15

    Treasury Inflow, Import Surge

    The mistake. The frequent error is calling both outcomes determinate and concluding the dollar appreciates because the stem opens with foreigners buying US bonds. The import surge pushes the dollar the other way, so without a statement about which shift is larger only the quantity of dollars traded can be signed; a related mistake is drawing the second shift as a movement along the supply curve rather than a shift of it.

    Draw this instead. Demand for dollars (D$) shifts right and Supply of dollars (S$) shifts right.

    Exam tip. When both curves shift the same direction on the foreign exchange graph, the quantity of dollars traded moves that way for certain and the exchange rate is the variable you must label indeterminate.

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