FIGURE 2 THE FOREIGN EXCHANGE MARKET
Data for dollars and pounds are graphically represented here. Panel A shows a market for dollars in which the price of dollars is denominated in pounds (£/$). In panel A, the market is in equilibrium at £0.56 per dollar (point e). Panel B shows the equivalent market for pounds in equilibrium at $1.78 per pound (again at point e). A rise in the demand for dollars means that the dollar appreciates to £0.75 per dollar (point a in panel A). Panel B shows that the corresponding decline in demand for pounds (from D0 to D1) leads to a depreciation of the pound as the exchange rate falls from $1.78 to $1.33 per pound (point b).
Note that a depreciating pound in panel B indicates a decline in the exchange rate, but this simultaneously represents an appreciating dollar. Thus, graphs can be viewed as reflecting either appreciation or depreciation, depending on which currency is being used to establish the point of view.