Question

Keeping other factors constant, explain how a spending of foreign tourists in the home country and fees payments of overseas students affect the demand and supply of foreign exchange.

Hint:

Inflows of foreign currency raise its supply and outflows raise its demand. Tourist spending and fees paid by overseas students are inflows. Fees paid abroad are outflows.

Answer 1

Step 1: Recall the foreign exchange market:
The foreign exchange market is where one currency is bought and sold for another.
Demand for foreign exchange comes from payments made to the rest of the world, such as imports and fees paid abroad.
Supply of foreign exchange comes from receipts from the rest of the world, such as exports and spending by foreigners at home.

Step 2: Effect of spending by foreign tourists in the home country:
A foreign tourist pays for hotels, travel and shopping in the home country. The tourist brings foreign currency and exchanges it for home currency.
This is an inflow of foreign exchange. The supply of foreign exchange therefore increases.
The supply curve shifts to the right. With demand unchanged, the price of foreign exchange (the exchange rate) falls.

Step 3: Effect of fee payments of overseas students:
Fees move in two ways. When overseas students pay fees to institutions in the home country, foreign exchange flows in.
This again raises the supply of foreign exchange.
When students of the home country pay fees to institutions abroad, foreign exchange flows out. Then the demand for foreign exchange rises.

Step 4: Join the two effects:
Tourist spending in the home country raises the supply of foreign exchange.
Fee payments raise the supply if they come in from abroad. They raise the demand if they go out of the country.
Other factors are kept constant, so only these flows decide the shift.

Final Answer:
Spending by foreign tourists in the home country increases the supply of foreign exchange. Fee payments increase the supply when they flow in from abroad and the demand when they flow out.