Exchange Rate Determination So Dollar 3.00 Depreciation 2.50 2.00 E Dollars per Pound 1.50 Dollar 1.00 Appreciation * 0.50 Do 0 1 2 3 4 5 6 7 Billions of PoundsGiven the supply and demand schedules of EiglLlll, there is no reason for the exchange rate to deviate from the equilibrium level. In practice, however, it is unlikely that the equilibrium exchange rate will remain long at the existing level. This is because the forces that underlie the location of the supply and demand schedules tend to change over time, causing shifts in the schedules. Should the demand for pounds shift rightward (an increase in demand), the dollar will depreciate against the pound,- leftward shifts in the demand for pounds [a decrease in demand) cause the dollar to appreciate. Conversely, a rightward shift in the supply of pounds [increase in supply) causes the dollar to appreciate against the pound; a leftward shift in the supply of pounds [decrease in supply) results in a depreciation of the dollar. The effects of an appreciating and depreciating dollar are summarized in Table 11.6. Like most demand schedules, the U.S. demand for pounds varies inversely with its price; that is, fewer pounds are demanded at higher prices than at lower prices. This relation is depicted by line D0 in igure 11.1. As the dollar depreciates against the pound [the dollar price ofthe pound rises), British goods and services become more expensive to U.S. importers. This is because more dollars are required to purchase each pound needed to finance the import purchases. The higher exchange rate reduces the number of imports bought, lowering the number of pounds demanded by U.S. residents. In like manner, an appreciation ofthe U.S. dollar relative to the pound would be expected to induce larger import purchases and more pounds demanded by U.S. residents