American tourists head to Europe

The chain in words

1. Step 1

   Before the summer

   This is the market for US dollars, priced in euros per dollar. The horizontal axis is the quantity of dollars traded. The vertical axis is the exchange rate. Demand comes from people who want dollars, supply from people who sell them. The market is at E₀.

2. Step 2

   Supply of dollars shifts right

   To pay for hotels in Rome, tourists sell dollars for euros. At every exchange rate, more dollars are offered, so the supply of dollars shifts right. At the old rate, more dollars are for sale than anyone wants.

3. Step 3

   The dollar depreciates

   The dollar falls. As it gets cheaper, Europeans find US goods and assets a bargain and buy more dollars, a movement along demand. The market settles at E₁: the dollar has depreciated and more dollars are traded.

Takeaway. Buying foreign goods, services, or assets means selling the home currency: supply shifts right and the currency depreciates.

Draw it yourself

More on the foreign exchange market graph