Final answer:
Foreigners demand dollars for trade, investment and because they expect the currency to appreciate. Export firms, tourists, and investors are the primary drivers of dollar demand. Shifts in demand and supply in the foreign exchange market influence the exchange rates and shift equilibrium.
Step-by-step explanation:
Foreigners demand dollars in the foreign exchange market for several key reasons. One primary reason is for the purpose of trade and investment. U.S export firms need to convert their earnings from foreign currency to U.S. dollars. Similarly, foreign investors purchase dollars to make financial investments in the U.S. economy due to opportunities or higher returns. The foreign exchange market enables this currency trade, where supply and demand determine the currency values. When a currency strengthens, or appreciates, it can purchase more of another currency and vice versa for a weaker, or depreciating, currency.
Shifts in the Foreign Exchange Market: Demand for the U.S. dollars can increase due to speculation or higher interest rates in the U.S., leading to appreciation of the U.S. dollar. Conversely, supply can decrease when international financial investors are less willing to sell their dollars, further driving up its value. These shifts affect the equilibrium exchange rates and volumes traded in the foreign exchange market.