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## Finance and capital markets

### Course: Finance and capital markets>Unit 8

Lesson 5: Foreign exchange and trade

# Currency effect on trade review

Currency Effect on Trade Review. Created by Sal Khan.

## Want to join the conversation?

• 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?
• 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...
• 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.
• its like his example happens a million times a second
• wat happens if we all use the same currency wouldnt that be better?
• 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.
• 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?
• i honestly think that it does not cost a whole dollar to make a doll so the left over value is the profit but im not sure.
• 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)
• 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.
• 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?
• 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 ?
• Aren't trade contracts negotiated in USD, usually? So the Chinese convert to USD in China .
• 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)
• 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)
• 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.