"MODEL OF EXCHANGE RATE DETERMINATIONStudent’s NameCourseDateModel of Exchange Rate DeterminationThe model of the exchange rate determination is a series of steps used to control theforeign exchange rates on the basis of demand and supply of currencies. The technique ensuresthat there is a balance between the supply and demand of exchanges. An imbalance in the forexis corrected by adjusting the price or the quantity of the traded currencies. Excess supply anddemand in the market is improved by changing the exchange rates between the currencies so thatequilibrium is reached. The model has the following approaches: the monetarist approach and thebalance of payment system. The two methods are used in determining the correct exchange rates.Equilibrium is a condition in which the supply for a currency and the demand is equal.Hence, stability in the prices of the two exchanging currencies. The equilibrium exchange ratetakes into account the differences in interest rates, inflation, and other factors affecting an1 economy. It is a specific rate at which import spending and export revenues are the same for aparticular country. Equilibrium point is reached after regulation of the import costs and theregulation of export revenues to ensure that the demand for domestic currency is equal to thesupply of foreign currency. Equilibrium is normally reached between two specific tradingcurrencies. Changes in domestic and foreign money supply and demand affect the equilibrium pointand conditions. An increase in the supply of domestic currency shifts the demand curve to the1James, Jessica, Ian W Marsh, and Lucio Sarno. Handbook of exchange rates. Hoboken: John Wiley & Sons, Inc.,2012. 2 right and push up the exchange rate of the domestic currency against the foreign currency. Agood example of this scenario is exhibited when a country increases its exports to anothercountry hence increasing the supply of the foreign currency. This increases the supply ofdomestic currency hence increasing the exchange rate of the domestic currency against the3 foreign currency. On the other hand, a decrease in the supply of domestic currency shifts thedemand curve to the left and decrease the exchange rate of the domestic currency against foreigncurrency. The best example of this scenario occurs when a country increases imports fromanother country hence increasing the supply of domestic currency.In order to attain a new equilibrium, a country must regulate the supply of domesticcurrency and the demand for foreign currency. In case the interest rates for domestic currencyagainst foreign currency are low, a country needs to reduce importation and increase exports to4 the specific country. This will help to reduce supply of domestic currency hence shifting thedemand curve to the right. On the other hand, in case the interest rates for domestic currencyagainst foreign currency are high, a country needs to increase importation and reduce exports tothe specific country. This will help to increase supply of domestic currency hence shifting thedemand curve to the left. A country needs to ensure that import spending and export revenues areequal at all times in order to maintain equilibrium. Countries also need to control supply of2Wang, Peijie. The economics of foreign exchange and global finance. Berlin: Springer-Verlag, 2009.3James, Jessica, Ian W Marsh, and Lucio Sarno. Handbook of exchange rates. Hoboken: John Wiley & Sons, Inc.,2012.4Wang, Peijie. The economics of foreign exchange and global finance. Berlin: Springer-Verlag, 2009. "