ABSTRACT
This chapter explains why the supply and demand model works in analyzing exchange rates - in the same manner. The interaction of the supply and demand for foreign exchange determines the equilibrium rate in a free market. The chapter discusses price levels and exchange rates with a simple but powerful statement known as the law of one price. It examines the absolute version of purchasing power parity using the dollar per pound exchange rate. It is obvious for a casual observer that exchange rates change frequently. These volatility, are a source of aggravation for individuals, businesses, and governments. The chapter gives what economists know about the effects of exchange-rate volatility on international trade and how changes in exchange rates affect the prices of the goods and services people purchase. It deals with the underlying value of a currency. While the exchange rate people observe in the market often differs from that value, and to know what that value is.
