Lesson plans · AP Macro Unit 6 · MACRO 6.2, MACRO 6.3, MACRO 6.4, MACRO 6.5, MACRO 6.1
Exchange Rates and the Foreign Exchange Market
Essential question: What moves a currency's value, and how does a change in interest rates travel through the exchange rate to net exports and aggregate demand?
2 × 50-minute periods · MACRO 6.2, MACRO 6.3, MACRO 6.4, MACRO 6.5, MACRO 6.1 · prints clean with Cmd/Ctrl+P
Objectives
- Students will be able to draw a correctly labeled foreign exchange market for one currency, with the quantity of that currency on the horizontal axis and its price in a named foreign currency on the vertical axis.
- Students will be able to determine whether an event shifts the demand for or supply of a currency and predict appreciation or depreciation.
- Students will be able to trace the chain from an interest rate change to capital flows, the exchange rate, net exports, and aggregate demand.
- Students will be able to explain how appreciation and depreciation change exports, imports, and net exports.
- Students will be able to relate the current account and the capital and financial account, which mirror each other to sum to zero.
Materials (all free, no student accounts needed)
Warm-up (8 min)
- Project the September 2022 pound crash: after an unfunded 45-billion-pound tax cut, the pound fell to $1.035, its lowest ever, within hours. Ask what traders were reacting to.
- Cold-call two students, then state the day's frame: an exchange rate is just a price, set by supply and demand for a currency.
- Write the axis reminder on the board: for the dollar market, quantity of dollars on the horizontal axis and price in euros per dollar on the vertical.
Direct instruction (30 min)
- Build the dollar market live. Demand for dollars comes from foreigners buying U.S. goods, services, and assets, and supply of dollars comes from Americans buying foreign goods, services, and assets.
- Define appreciation (a dollar buys more foreign currency) and depreciation (it buys less), and stress that when one currency appreciates the other depreciates.
- List the shifters and keep them relative: interest rate differentials, relative income growth, relative inflation, speculation and expectations, and tastes. Interest rate differentials act fastest.
- Work the trade link: appreciation makes exports pricier abroad and imports cheaper at home, so net exports fall, and depreciation reverses it. Use the euros-per-dollar numbers from the lesson.
- Trace the full chain and write it as arrows: interest rates up, capital flows in, dollar appreciates, net exports fall, aggregate demand shifts left. Tell students the FRQ hands them one link and asks for the next.
Guided practice (32 min)
- Project /sandbox/exchange-rates for the dollar. Reset to equilibrium and label the axes with euros per dollar so every student copies the correct labels.
- Tell the class U.S. interest rates rise while the ECB holds steady. Have students predict the shift, then drag the demand for dollars to the right and confirm the dollar appreciates.
- Cold-call the next link: what happens to U.S. exports, imports, and net exports now that the dollar is stronger?
- Run the trap case: Americans take more vacations in Europe. Ask which curve moves. Confirm they SUPPLY dollars, so supply shifts right and the dollar depreciates, rather than shifting dollar demand.
- Open /graph-walkthroughs to the 'US Interest Rates Rise: The Dollar Appreciates' walkthrough and step through it as a class to lock in the interest-to-net-exports chain.
- Finish with a relative-rates check: tell students a foreign central bank hikes while the U.S. holds steady, and cold-call whether the dollar rises or falls. Confirm it depreciates because only the differential matters.
Independent practice (25 min)
- Have students work the 8 questions shown on /practice/exchange-rates, watching for anyone who shifts dollar demand when Americans buy imports.
- Send fast finishers to /frq-practice/draw for the dollar-appreciation scenario and have them carry it all the way through the interest-to-net-exports chain, not just the currency shift, before checking the model answer.
Exit ticket
- On a card, draw and label the market for dollars showing the effect of a Federal Reserve rate hike relative to other countries.
- In one sentence, state what happens to the dollar and to U.S. net exports.
Homework
- Work through the full exchange-rates bank on /practice-test (choose the exchange rates module).
- Read the 'Balance of Payments and Monetary Policy' section of /macro/exchange-rates and write two sentences explaining how a current account deficit is financed by a capital account surplus.
Differentiation
- Support: run a currency-pair reading drill first, quoting the same move as both euros per dollar and dollars per euro, so students can say which currency appreciated before they touch a graph.
- Support: hand out a 'who needs which currency' card, foreigners buying U.S. assets demand dollars, Americans vacationing abroad supply them, so students map each event to a curve before graphing.
- Extension: have students trace expansionary monetary policy through both the domestic investment channel and the exchange-rate channel and explain why the two reinforce each other.
- Extension: assign the fixed-exchange-rate question and have students explain why a peg fails under a persistent current account deficit.
Misconceptions to head off
- Students shift the demand for dollars when Americans buy imports. Correct it: Americans SUPPLY dollars to obtain foreign currency, so the dollar supply curve shifts right and the dollar depreciates.
- Students read a rise in dollars-per-euro as dollar appreciation. Correct it: if it takes more dollars to buy a euro, the dollar has DEPRECIATED and the euro has appreciated, so read the axis before answering.
- Students reverse the net export sign. Correct it: depreciation makes exports cheaper abroad, so net exports rise, while appreciation lowers net exports.
- Students judge a currency by the country's own interest rate level. Correct it: exchange rates move on the RELATIVE differential, so a foreign hike with U.S. rates unchanged still depreciates the dollar.
Teacher FAQ
- Where does this fall and how long does it take?
- It anchors Unit 6, the open-economy unit. Two 50-minute periods are enough: one to build the foreign exchange graph and the shifters, one for the interest-to-net-exports chain and practice.
- What is the single biggest point loser to warn students about?
- Axis labels and the supply-versus-demand trap. The foreign exchange FRQ wants specific currency labels like euros per dollar, and it punishes students who shift dollar demand when Americans are actually supplying dollars to buy imports. Drill both in guided practice.
- How do I grade the exit ticket?
- Full credit needs a correctly labeled dollar market, the demand for dollars shifting right for the rate hike, the dollar appreciating, and net exports falling. The most common miss is stopping at appreciation without carrying the chain to net exports.
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