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Video transcript

in a previous video we've given an intuition on what foreign exchange markets are all about in particular we talked about the foreign exchange market between the US dollar and the Chinese WAN what we're going to do in this video is think about the same idea but think about it in terms of graphs and the types of economic models that we're used to seeing in an introductory macroeconomics course so what we're going to focus on in this video is the foreign exchange market foreign exchange market for the Chinese one now we're going to think about it in terms of supply and demand curves it can be a little bit confusing because we're gonna be thinking of the price of the one in terms of another currency in this case the dollar although you could do it in terms of other currencies the the pound of the euro or whatever else now this can be a little bit confusing because we're going to be thinking about currency on both axes but let's first think about the horizontal axis that when we were thinking about most markets that is our quantity axis and here once again we were to think about quantity we're gonna think about the quantity quantity of Chinese of Chinese one and then our vertical axis we're essentially going to be thinking about the price of the Chinese one but how do you think about the price of a currency well we're going to think of it in terms of another currency and for the sake of this video that other currency is going to be the US dollar so this is going to be US u.s. dollars dollars per Chinese Chinese one and I encourage you pause this video think deeply about why it's u.s. dollars per Chinese wan as opposed to Chinese one per US Dollars and think about why I put the quantity of Chinese wan here sort of the quantity of US dollars because this is the foreign exchange market for the Chinese one I could have done another chart where's the foreign exchange market for the US dollar in which case then my quantity would be US dollar and then I would think of how much of some other currency per US dollar so I would say maybe how much Chinese won per US dollar but here's the other way around I'm in the market for the Chinese one so let's think about the supply and demand curves and which way they would work well imagine that people are offering very few US dollars per Chinese one well in that world a lot of people might not want to convert their wan into dollars they might not offer them up to up for supply to be converted into US Dollars and so the quantity of Chinese wan if the price for the chinese wan is low might be pretty low and as the price people are willing to pay in terms of dollars goes up well more and more people might be willing to transact so our supply curve and here we're talking about the supply for Chinese Wan is likely to increase as people are willing to pay more for those wands and this is like many markets that we've seen before this is just a little bit less intuitive because we're thinking about markets for one currency in terms of another currency now what about the demand curve well the demand curves gonna look like a lot of demand curves we've seen if the price of a Chinese want is high well very few people are going to demand it and as the price of the Chinese want in terms of dollars is lower and lower more and more people might demand more Chinese one like a it's cheaper now in terms of US dollars so this is what a demand curve might look like and as you could imagine this point is our equilibrium point and it would tell us our equilibrium exchange rate and so we could call that our equilibrium exchange rate and this would be our equilibrium our equilibrium quantity so for example let's say that our equilibrium quantity and let's say this is the quantity that changes hands in some time period so let's say per day let's say our equilibrium quantity is equal to one thousand one one thousand one let me just call this Q sub one is one thousand one these numbers are very low real exchange markets we might be talking about billions or tens or hundreds of billions or even sometimes trillions of various currency but let's just say for argument it's one thousand one is our current equilibrium exchange quantity per day and let's say this exchange rate a sub 1 is equal to 10 cents per one so 10 10 cents or 1/10 of a US dollar per Chinese one so that's our current exchange rate now let's say for some reason all of a sudden Americans are very become increasingly interested in converting their currency maybe they want to invest in China maybe all of a sudden the Chinese say hey Americans come buy property in China a lot of people are interested well what would happen here well then the demand for wan would increase because you can only buy that property in China with Wan not with US dollars and so what would happen here well your demand curve would shift to the right like we've seen before and so if we call this d1 then we could get to a new demand curve that might look something like this d2 now what would happen if our equilibrium exchange rate doesn't change well if this is our exchange rate if this were to stay our exchange rate now all of a sudden a higher quantity is being demanded than is being supplied the Americans in this situation or it actually doesn't even have to be Americans it could just be whoever is holding US dollars there's demand for more than a thousand one per day maybe this is 1,500 1 or whatever it might be and so what you would naturally see is that the price of the one in terms of u.s. dollars will go up until you get to an equilibrium point and on the first video when we talk about the intuition of foreign exchange markets we talk about why this would be so you would then get to a new equilibrium right over here this is e sub 2 and a new equilibrium quantity let's call this Q to our new equilibrium quantity Q 2 might be 1200 one per day versus 1000 1 per day and our new equilibrium exchange rate may be this is now equal to 15 cents per wan instead of 10 cents for one so big picture you can think of the foreign exchange market in a lot of ways like we've looked at other markets in macroeconomic it's just a little bit takes a little bit of an intuitive leap to just think about the market for one currency in terms of another
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