Economics "Ask the Instructor" Clip 4 Transcript
How is our economy related to the rest of the world?
The short answer is more so today than in the past. But you want to know some specifics. Right? Well, here we will focus on the impact that exchange rates have on exports and imports.
The exchange rate is a price. It’s the price of one country’s currency in terms of another country’s currency. The dollar-yen exchange rate in June 2001 was about 120. That means the price of the U.S. dollar in Japanese yen is 120. Of course that implies that the dollar price of the yen is about .008 or about eight tenths of one cent.
The exchange rate is determined by--you guessed it--demand and supply. If Japanese tastes shift in favor of US goods, or if more Japanese want to vacation in our country, they need to buy U.S. dollars. Thus, the demand for dollars shifts to the right and the yen price of dollars rises. On the other hand, if US consumers want to purchase more Japanese goods or if vacationing in Japan becomes more popular with U.S. consumers, the demand for Yen will rise and the dollar price of yen will rise. Of course this means that the yen price of the dollar falls.
The demand for another country’s currency is also impacted by factors other than a change in tastes or preferences. One example is the overall economic conditions in a country. If the US economy is growing at a faster rate than the Japanese economy, demand for foreign travel by U.S. residents and for imports by U.S. residents will likely increase. This would tend to make the dollar weaker in relation to the yen, that is the yen price of the dollar would fall.
Changes in exchange rates affect the amount of imports and exports by changing their prices. For example, if the dollar weakens relative to the yen, the price of US wheat to Japanese importers declines. This is good news to wheat growers in the Midwest. But it’s bad news for US businesses and consumers who want to import more goods from Japan or travel in Japan. The reason is that now more dollars are required to purchase yen.
Between WWII and the early 1970s the US and other countries attempted to keep exchange rates stable. However, in recent decades exchange rates have been allowed to rise and fall in response to shifts in supply and demand, just like the price of any other good or service sold in free markets. So you may be lucky enough to get a better dollar price on an imported good or travel abroad by timing your purchase when the dollar is strong. Or you may be unlucky and buy when the dollar is weak.
There are even ways to “lock-in” an exchange rate by buying in the futures market. But, in the mean time, just remember, that our economy is connected with the rest of the world through trade and exchange rates play an important role in determining the cost of imports and exports.