📚 Topic Summary
Exchange rates determine the value of one currency in terms of another. In a fixed exchange rate system, a country's central bank intervenes in the foreign exchange market to maintain its currency's value at a specific level. This often involves buying or selling its own currency to offset market pressures. Conversely, in a flexible exchange rate system (also known as a floating exchange rate), the value of a currency is determined by supply and demand in the foreign exchange market, with minimal or no government intervention. These systems have different implications for a country's monetary policy, trade balance, and overall economic stability. Understanding the nuances is key for AP Macro!
🧠 Part A: Vocabulary
Match the terms with their definitions:
| Term |
Definition |
| 1. Appreciation |
A. A system where currency value is determined by supply and demand |
| 2. Depreciation |
B. Government action to decrease the value of a currency |
| 3. Devaluation |
C. An increase in the value of a currency in a flexible exchange rate system |
| 4. Revaluation |
D. A decrease in the value of a currency in a flexible exchange rate system |
| 5. Flexible Exchange Rate |
E. Government action to increase the value of a currency |
(Answers: 1-C, 2-D, 3-B, 4-E, 5-A)
✏️ Part B: Fill in the Blanks
In a fixed exchange rate system, if a country's currency is overvalued, the central bank must ______ its own currency to maintain the fixed rate. This action will ______ the supply of the domestic currency and ______ the demand, bringing the exchange rate back to the target level. This can lead to a depletion of the country's ______ reserves over time.
(Answers: sell, increase, decrease, foreign)
🌍 Part C: Critical Thinking
Discuss the advantages and disadvantages of a country adopting a fixed versus a flexible exchange rate system. Consider factors such as economic stability, monetary policy autonomy, and vulnerability to external shocks.