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Currency effect on trade review

Currency Effect on Trade Review. Created by Sal Khan.

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  • female robot grace style avatar for user katieldouglass
    A question about currency differences in general: why should ten yuan equal one dollar in the first place? Why isn't one yuan equal to one dollar? Does it have to do with inflation, i.e. the yuan is more inflated than the dollar is, so you need more of it to buy something? Or does it have something to do with trade or government regulation?
    (10 votes)
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    • leaf green style avatar for user PetoG
      To answer your question "why should ten yuan equal one dollar in the first place": It also has something to the with how much value a currency have in it's own country. Imagine there are two countries which never had any contact with each other before. In one country they use currency A, in other currency B. These two countries have little in common, but they both plant apples. In one country, one apple costs 1 A, in the other country one apple costs 10 B's. So naturally, first time these two countries make contact, they would probably agree, that they would exchange 1 A for 10 B's.

      From other point of view. Imagine the US government would decide they want a new currency - SuperDollar. They will start printing this new money and they will tell everybody, that they will exchange their 10 dollars for 1 SuperDollar. What happens? Well, all the prices and salaries will now be 10 times smaller (what costed 10 dollars would now be 1 SuperDollar, if you earned 10000 Dollars per month, you would now earn 1000 SuperDollars per month...) So in the end, nothing really changes, you only scratch one zero. But if you would get 10 Yuans for one dollar before, now it would be 100 Yuans for one SuperDollar. Does it mean that the american currency is all of a sudden 10 times better than it was before? No, it's just that inside the country they now use smaller numbers to describe prices of things.

      But of course, the values change over time following the rules like described in this video, but you asked about how it is at the beginning...
      (53 votes)
  • blobby green style avatar for user Gavin McLeod
    Nice story - thank you.
    However, balance never occurs. Aren't exchange rates, in a real market situation, constantly changing? Who decides the relative value of all the goods and services traded? And how about all the other countries trading across these goods at the same time? I know this is just an example but there appears a lot more to it than this model shows. Still, thank you for a great start.
    (17 votes)
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  • male robot hal style avatar for user Casey Hernandez
    wat happens if we all use the same currency wouldnt that be better?
    (2 votes)
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    • blobby green style avatar for user martin
      No, because the currency reflects a countries economy. Lets say you have two countries producing similar goods (cars, computers etc.). One is bigger and richer and can effectivize its production to cut production costs and therefore becoming more competitive internationally. The 2nd country is smaller and poorer, it hence finds it harder to increase the efficiency of its production on the same scale as the larger country. To compensate for this problem it instead devalues its currency making it competitive internationally, therefore counterbalancing the more industrialized states natural advantage. Tourist countries used the same method to increase tourism. Devaluating currencies does however increase cost of imports, but that can be positive if there is a strong domestic industry and agriculture.
      (8 votes)
  • mr pants teal style avatar for user krishna
    At , Sal says the manufacturer ships a 100 dolls to the US, and the seller sends back $100 to the manufacturer. How then does the seller make his profits?
    (3 votes)
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  • male robot hal style avatar for user ben m
    What happens if you run a business in both china and the us, can you keep both sets of currency so you're not effected by currency market fluctuations?
    (1 vote)
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    • male robot hal style avatar for user Andrew M
      Yes, you may be able to pay all your bills in China with yuan that you receive as revenue in China, and all your bills in the US with dollars that you receive as revenue in US. But ultimately, you live somewhere, and you will probably want to convert your profits to your home currency. You can reduce the volatility of your foreign currency exposure but you can't eliminate it.
      (2 votes)
  • blobby green style avatar for user jjkirshbaum
    Doesn't this scenario only work is demand is based on price only? At a certain point there will be a negligible increase in the demand for cola for a reduction in price. Let's say that the increase in demand for cola (or the entire basket of US goods) approaches zero as the demand approaches 70 cans, and that because the dolls (or the Chinese basket of goods) are so massively popular, the demand for the dolls approaches 4 as the price of doll rises even to very high prices (think of those Elmo dolls everyone was fighting for) then wouldn't there still be a trade gap even though there are floating exchange rates. In very simple terms- what if Chinese products are more attractive to the US than the other way around?
    (2 votes)
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  • piceratops seedling style avatar for user ronitkamboj007
    If the author in the last bit; instead of 60 dolls demand in US and 75 colas' demand in China, used another set of values, say 54 dolls and 93 colas.
    Then the trade balance would not work out.
    How do you know by how much the demand is expected to change ?
    (2 votes)
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  • blobby green style avatar for user Marc Blazek
    Aren't trade contracts negotiated in USD, usually? So the Chinese convert to USD in China .
    (2 votes)
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    • male robot hal style avatar for user hmccosh
      Yes, it's not that hard to find out how much of their currency is worth in US dollars. But anyways, trade is not done in just cash, especially US dollars. Trade is done with imports/exports and if they use any currency, it will be the globally accepted gold. Money really only resembles the value of what it took to get it ( a good or a service), and that value may be paid off in a different way.
      (1 vote)
  • duskpin ultimate style avatar for user Fred12
    but the question is, iff he exchanges 100 $ into yuan, but there is not such amount of yuan, the yuan will rise in its value, lets say he gets 80 yuan for it, but will the inland prices get down as much as the value of the yuan is changing? I mean if you bought 1 bread for 1 yuan, and the price for yuan has risen, so you get 800 yuan for 100 dollars, will bread still cost 1 yuan or 0.8 yuan? -because if the prices were still the same, you would actually have less money to spend than before...

    how is market adapting that fast to the price??
    (1 vote)
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    • leaf blue style avatar for user Aaron Y
      The market rarely changes at extreme rates like 20%; it's more like 1%-5% of difference annually, with a tendency towards balancing itself. Companies usually feel these effects before any consumer would and they can decide how to handle it. Wal-Mart may sneakily charge 3 cents extra on one popular good, effectively offsetting the extra 1% to all goods cost, and allow bread to remain the same price. Or they might not bother with it at all, since they'll make it back next year when the exchange rates tilt towards their favor. Oil prices, on the other hand, fluctuate almost daily based on market exchange rates.
      (3 votes)
  • spunky sam blue style avatar for user Siang Billy
    If trading currencies are rather complicated, why can't the whole world use the same currency? What would happen if the world uses the same currency?
    (1 vote)
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    • piceratops ultimate style avatar for user Mike Xie
      The only way the whole world will use one currency is either if all the nations become one, an alien invasion hits and we have to band together for centuries, or if the private bankers managed to take over the world in a new world order.
      (3 votes)

Video transcript

Let's review what happened in the last video because, in general, it's just kind of confusing and it's always good to see it a second time. And then we can think a little bit about how these market dynamics could be manipulated so that you don't have the Chinese currency getting more expensive. So the last video, we started off with an exchange rate of CNY 10 per dollar. We saw that this manufacturer over here in China had to sell his goods for the equivalent of CNY 10 in order for him to make a profit and that this guy in United States had to sell his goods abroad-- or we'll say in China-- for the equivalent of $1. Now it's this exchange rate, this price was $1 and at this exchange rate, this guy had to sell his cola for CNY 10 so that he could get his dollar. So we kind of just drew it out. And we said at that price, so for CNY 10 which was $1, at $1 there was demand for 100 dolls in the United States. So we saw this dynamic,. He would ship 100 dolls to the United States and then the United States would ship him back $100. He would sell those dolls for essentially $1 each, he would get back $100. On the other side of the equation, the cola manufacturer, if he were to sell it for CNY 10 in China, there's demand for 50 cans of soda. So he would send 50 cans of soda to China and they would send them CNY 10 for each can, CNY 500. Now, what happened in that situation is that the Chinese manufacturer had CNY 1,000 that he needs to convert into dollars, into $100 preferably, if that exchange rate were fixed. The American manufacturer, and let's say that these are the only two actors in our scenario, has CNY 500 that he needs to convert into $50. So if we just look over here, here's someone who wants to convert CNY 1,000. Or he wants to convert into CNY 1,000, let me be very careful. He wants to convert his $100 into CNY 1,000 if the currency were to be held constant. But there's only CNY 500 being offered in the market. So he was going to have to offer more dollars per Yuan then he would if there was more Yuan in the market. Now you can look at it from the other side. This American manufacturer has CNY 500 from his sales in China. He wants to convert it if the currency was pegged into $50, but maybe he could do better than $50 here. And as we can see, there's more demand to convert the Yuan than there is to convert the dollars. He wants to buy $50 using Yuan. This guy wants to sell $100 into Yuan. So if you look over here, the supply of dollars is much greater than the demand for dollars. And you know in anything, if the supply of apples is greater than the demand for apples, then the price of apples would go down. And the opposite is happening here with the Yuan. The demand for Yuan-- this is the demand-- is much greater then the supply of Yuan. And we know that when the demand is greater than the supply, the price needs to go up. And so we saw a scenario where the price of the dollar will go down in terms of Yuan. Now all that means is if you have to give CNY 10 per dollar, now you're going to have to give fewer Yuan per dollar. The price of Yuan would go down. If the price of apples in Yuan goes down, instead of offering CNY 10 per apple, you'd probably offer CNY 8 per apple. So we see the exact same thing for the price of the dollar. But that's equivalent to saying the price of a Yuan goes up. Now we said eventually, and I'm just making this number up, it's hard to predict what the actual settling price would be, we eventually get to CNY 8 per dollar. And then we said, at that exchange-- and actually I'm going to change the numbers a little bit just to make it a little bi cleaner-- at that exchange rate, at CNY 8 per dollar, these 10-Yuan dolls would now cost $1.25. And let's say that at $1.25, in the United States, there is a demand for 60 dolls. I'm changing the numbers a little bit from the last video just to make the numbers work out a little bit better. So you can just ignore the numbers from the last video. And remember, the older demand when the 10-Yuan dolls were only $1, so the old demand was 100 dolls. So it makes sense. If dolls are $1, people are going to have more of them. If dolls go up to $1.25, the demand will go down and say they'll go down to 60 dolls. Now on the other side of the equation, the $1 can of soda at CNY 8 per dollar will now sell in China for CNY 8. And remember what the old price was. The old price in China where the currency rate was 10 to 1 was CNY 10. So the price-- let me write it here-- the price the cola went from CNY 10 down to CNY 8. So the demand, now that the cola is cheaper in China, the demand went up. And I'll change this number too, so don't do the 80 cans. We'll say that the demand in China went from 50 cans, we saw that up here-- he had to ship 50 cans when it cost CNY 10 per can-- So it went from 50 cans up to-- maybe I make it go up-- the demand went from 50 up to, let's say, 75 cans. I'm using these numbers because it's going to lead to cleaner numbers. So now what is the actual scenario? In the last video I said work it out yourself, but I realize the more concrete examples of this, the more it will kind of sink into your brain. So now what is the trade balance going on? So going from China, and then you have the U.S. Over here we're going to be shipping 60 dolls. And then the U.S. is going to ship back 60 times $1.25, that is $75, right? $1.25 for 60 dolls means you're going to get $75. So $75 is going to go back to China. So that's due to the dolls, and now let's think about what's going to happen due to the soda. We are going to have 75 cans of soda are going to be shipped to China and then China is going to send back 75 cans at CNY 8 per can. 75 times 8, 600. So for the 75 cans, he is going to get back CNY 600. So now what's happening? The Chinese manufacturer over here on the left wants to convert $75 into-- if we assume that the currency is now eight, and he says, well, I'll just it get at the market rate-- into roughly CNY 600. 75 times 8 is 600. CNY 8 per dollar. And then the U.S. manufacturer wants to convert-- He's got CNY 600 from his sale of soda and, if he assumes he can get kind of the last market rate, 600 divided by 8 is into $75. So what just happened here? Now the supply of dollars is equal to the demand for dollars. And also, the supply of Yuan right over here is equal to the demand for Yuan. So now, depending on how you view it, we're sending the same dollar value to the U.S. as we're sending back to China, or we're sending the same Yuan value to the U.S. as we're sending back to China. And the currency is now in balance. It really shouldn't shift. So I really wanted to go through this example again to show you that when you have freely floating currencies, eventually one currency should get more-- if there is a trade imbalance-- expensive than the other until the demand equalizes in both countries so that you eventually do have a trade balance. Hopefully that doesn't confuse you too much, and in the next video, we'll talk about how a government-- and we'll talk about the Chinese Central Bank in particular-- could intervene so that this doesn't happen, so that they can always ship more to the U.S. than the U.S. ships to China.