IB Econ Exchange Rates And Balance Of P
Ash Chen
IB Economics SL
Mr. Murf
Exchange Rates and The Balance of Payments
Exchange Rates Living in the 21st century, trading has become a major component of our global economy. However, with over 200 countries and 180 currencies in the world, countries cannot trade with each other without a way to pay each other in their currency. Thus, in order to trade, countries have developed a formula to convert their money to that of another country’s. That formula is the exchange rate.
The exchange rate is the rate at which a country’s currency can be exchanged for that of another country. For example, lets consider the Chinese Yuan and the Hong Kong Dollar. The number of Dollar per Yuan is 1.267. And the number of Yuan per Dollar is 0.789. The first expression shows us the value of 1 Yuan in terms of Dollars or how many Dollars must be given up in order to buy 1 Yuan. Whereas the second expression shows us the value of 1 Dollar in terms of Yuan or how many Yuan must be given up in order to buy 1 dollar. These 2 equations have to be equivalent since the value of each currency is expressed in terms of another. Which also means that the 2 exchange rates are reciprocals of each other. In the foreign exchange market, the price of one currency must always be expressed in terms of another currency. This is because there is no independent unit that we can use to empress the value of currencies.
Now we will examine how the exchange rates were determined. There are 2 ‘pure’ exchange rate systems: the floating (flexible) exchange rate system, and the fixed exchange rate system. We will also examine the actual system in use today, known as the manage float (exchange rate) system, which lies between the 2 ‘pure’ systems. In a floating (flexible) exchange rate system, exchange rates are determined entirely by market forces, or the forces of supply and demand. There is no government intervention in the foreign exchange market to influence the value of currencies. For
IB Economics SL
Mr. Murf
Exchange Rates and The Balance of Payments
Exchange Rates Living in the 21st century, trading has become a major component of our global economy. However, with over 200 countries and 180 currencies in the world, countries cannot trade with each other without a way to pay each other in their currency. Thus, in order to trade, countries have developed a formula to convert their money to that of another country’s. That formula is the exchange rate.
The exchange rate is the rate at which a country’s currency can be exchanged for that of another country. For example, lets consider the Chinese Yuan and the Hong Kong Dollar. The number of Dollar per Yuan is 1.267. And the number of Yuan per Dollar is 0.789. The first expression shows us the value of 1 Yuan in terms of Dollars or how many Dollars must be given up in order to buy 1 Yuan. Whereas the second expression shows us the value of 1 Dollar in terms of Yuan or how many Yuan must be given up in order to buy 1 dollar. These 2 equations have to be equivalent since the value of each currency is expressed in terms of another. Which also means that the 2 exchange rates are reciprocals of each other. In the foreign exchange market, the price of one currency must always be expressed in terms of another currency. This is because there is no independent unit that we can use to empress the value of currencies.
Now we will examine how the exchange rates were determined. There are 2 ‘pure’ exchange rate systems: the floating (flexible) exchange rate system, and the fixed exchange rate system. We will also examine the actual system in use today, known as the manage float (exchange rate) system, which lies between the 2 ‘pure’ systems. In a floating (flexible) exchange rate system, exchange rates are determined entirely by market forces, or the forces of supply and demand. There is no government intervention in the foreign exchange market to influence the value of currencies. For