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What determines the number of units of one currency that a person is willing to give up for one unit of another person's currency? How, in other words, is it determined that one u.s. dollar will be exchanged for 150 Japanese yen or 0.80 British pound?
Figure 8.1 depicts the three main theoretical determinants of exchange rates. The exhibit assumes a more or less free market economy, in which direct governmental intervention is kept at a minimum. The theories deal with the short, medium, and long run. All three theories of exchange rate determinants assume that exchange rates are determined by the demand for and supply of a currency in the international market.
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