How is the exchange rate determined under a flexible exchange rate regime?

Under flexible or floating exchange rate regime, the exchange rate is determined by the interaction of market forces of demand and supply of foreign exchange in international market.

Central Bank does not intervene in foreign exchange market in deciding the exchange rate system.

Let us explain it with help of the following diagram

In the above diagram –

OX represents the Amount of Foreign Exchange

OY represents the Exchange Rate

DD is the downward sloping demand curve for foreign exchange

SS denotes the upward sloping supply curve of foreign exchange

X is the equilibrium point where demand and supply of foreign exchange are equal

Oe denotes the equilibrium exchange rate

Om denotes the equilibrium amount of foreign exchange