Page 122 - Economics

CONFIRMING PAGES

CHAPTER 5
93
The United States in the Global Economy
country to translate prices of foreign goods into units of Here the equilibrium price of 1 yen—the dollar-yen ex-
their own currency: They need only multiply the foreign change rate—is 1 cent per yen, or $.01 ¥1. At this price,
product price by the exchange rate. If the U.S. dollar–yen the market for yen clears; there is neither a shortage nor a
exchange rate is $.01 (1 cent) per yen, a Sony television set surplus of yen. The equilibrium $.01 price of 1 yen means
priced at ¥20,000 will cost $200 ( 20,000 $.01) in the
United States. If the exchange rate rises to $.02 CONSIDER THIS . . .
(2 cents) per yen, the television will cost $400 ( 20,000
$.02) in the United States. Similarly, all other Japanese A Ticket to Ride
products would double in price to U.S. buyers in response Have you ever attended a
to the altered exchange rate. county or state fair and spent
time on the rides? If so, you are
Dollar-Yen Market aware of the dual “currencies”
How does the foreign exchange market work? Let’s look often used there. One cur-
briefly at the market for dollars and yen. U.S. firms ex- rency is the dollar; the other is
the ride ticket. Rides are priced
porting goods to Japan want payment in dollars, not yen; in number of ride tickets, but
but the Japanese importers of those U.S. goods possess dollars are needed to buy tick-
yen, not dollars. So the Japanese importers supply their ets at the kiosks. Alternative
yen in exchange for dollars in the foreign exchange mar- rides require different numbers of tickets. For example, the
ket. At the same time, there are U.S. importers of Japanese roller-coaster may require 8 tickets; the twister, 6 tickets; and
goods who need to pay the Japanese exporters in yen, not the merry-go-round, 2 tickets.
dollars. These importers go to the foreign exchange mar- Exchange rates between dollars and other currencies are
ket as demanders of yen. We then have a analogous to the exchange rate between dollars and ride tick-
market in which the “price” is in dollars ets.* Such tickets are a “currency” used to buy rides, and dol-
and the “product” is yen. lars and tickets are exchanged.
Initially suppose that the dollar price of each ticket is $.25. If
Figure 5.3 shows the supply of yen (by you were to exchange tickets for dollars on the midway, you
Japanese importers) and the demand for would find that the ticket price of a dollar is 4; that is, 4 tickets
yen (by U.S. importers). The intersection will exchange for $1. The ticket-dollar exchange rate is 1 ticket
G 5.1 of demand curve D and supply curve S es- $.25, and the dollar-ticket exchange rate is $1 4 tickets.
y
y
Exchange rates tablishes the equilibrium dollar price of yen. Although the rides are priced in tickets, not dollars, the ex-
change rate permits quick conversion of ticket prices into dollars.
For example, the 8-ticket price of the roller-coaster ride converts
FIGURE 5.3 The market for yen. U.S. imports from Japan to $2 ( 8 tickets $.25). Exchange rates enable buyers to convert
create a demand D y for yen, while U.S. exports to Japan (Japan’s imports) goods priced in another currency to prices in their own currency.
create a supply S y of yen. The dollar price of 1 yen—the exchange rate—is
determined at the intersection of the supply and demand curves. In this case Next suppose that in some year the fair increases the price
the equilibrium price is $.01, meaning that 1 cent will buy 1 yen. of ride tickets from $.25 to $.50. The dollar has depreciated in
value, because more dollars (one-half rather than one-fourth)
P
are needed to buy each ticket. Ride tickets have appreciated in
S y value, because fewer tickets (two rather than four) are needed
to obtain a dollar. Specifically, the exchange rate has changed
Exchange
rate : $.01 ¥1 from 1 ticket $.25 to 1 ticket $.50 or, alternatively, from
Dollar price of 1 yen .01 before, the dollar price of the roller-coaster ride increases
$1 4 tickets to $1 2 tickets.
If the fair charges the same number of tickets per ride as
from $2 ( 8 tickets $.25) to $4 ( 8 tickets $.50). Other
things equal, depreciation of the dollar relative to another currency
increases the dollar price of goods and services that are priced in
the other currency.
D y *One difference, however, is that many exchange rates are free to fluc-
tuate depending on currency supply and demand. The fair operators fix
the dollar–ride ticket exchange rate. Another difference is that the fair
0 Q e Q
operators offer an unlimited quantity of tickets at that price.
Quantity of yen

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