Introduction to currency exchange and trade | AP Macroeconomics | Khan Academy

Summary

This video explores the impact of exchange rates on trade, using the depreciation of the Chinese Yuan against the US dollar as an example. It explains how such depreciation can make American goods more expensive in China, potentially reducing American imports, while making Chinese goods cheaper in the US, increasing Chinese imports. The video also discusses how changes in interest rates, influenced by factors like government borrowing, can shift currency supply and demand curves, further affecting exchange rates and trade dynamics.

Takeaways

• 🌐 The video discusses how exchange rates, specifically the depreciation of the Chinese Yuan against the US dollar, can influence trade dynamics.
• 📉 Depreciation of a currency can occur due to a decrease in demand for that currency or an increase in supply, leading to a shift in the exchange rate.
• 📊 The script uses a supply and demand graph to illustrate the equilibrium exchange rate and how shifts in supply or demand can affect this equilibrium.
• 🛒 For Chinese consumers, a depreciation of the Yuan makes imported US goods more expensive, potentially reducing the quantity of US goods imported into China.
• 📈 Conversely, in the US, a weaker Yuan makes Chinese goods cheaper, which could lead to an increase in Chinese imports.
• 🔄 The video suggests a potential negative feedback loop where changes in trade due to currency depreciation could eventually lead to currency appreciation.
• 🏦 The script links government borrowing and interest rates to exchange rates, explaining how increased US borrowing can raise interest rates and affect currency values.
• 💹 Higher interest rates in the US could make holding dollars more attractive to foreign investors, potentially leading to a depreciation of other currencies like the Yuan.
• 🌟 The video emphasizes the interconnectedness of exchange rates, trade, and economic policies, such as government borrowing and interest rates.
• 🔍 It also hints at further exploration of how factors like interest rate changes in each country can shift the supply and demand curves for currencies, impacting trade.

Q & A

What is the main focus of the video script?

The main focus of the video script is to explore how exchange rates can affect trade between countries, specifically looking at the impact of the Chinese Yuan depreciating versus the US dollar.

What is the role of the supply and demand curves in the exchange market for the Chinese Yuan?

The supply and demand curves in the exchange market for the Chinese Yuan illustrate the relationship between the quantity of Yuan and its price in terms of dollars. The supply curve represents those willing to exchange Yuan for dollars, while the demand curve represents those wanting to exchange dollars for Yuan.

What are the two ways in which the Chinese Yuan could depreciate versus the US dollar?

The Chinese Yuan could depreciate versus the US dollar either by a decrease in demand for Yuan (shifting the demand curve to the left) or an increase in supply of Yuan (shifting the supply curve to the right).

How does the depreciation of the Chinese Yuan affect the cost of American goods in China?

When the Chinese Yuan depreciates, it requires more Yuan to equal the same amount of US dollars. This makes American goods, which are priced in dollars, more expensive for Chinese consumers, potentially leading to a decrease in demand for these goods.

What is the likely impact of a depreciated Yuan on American imports into China?

A depreciated Yuan makes American imports more expensive in China, which is likely to result in a decrease in the quantity of American goods imported into China.

How does the depreciation of the Chinese Yuan affect the price of Chinese goods for American consumers?

A depreciated Yuan means that fewer dollars are needed to buy the same amount of Yuan, making Chinese goods cheaper for American consumers, which could lead to an increase in demand for these goods in the US.

What is the potential negative self-correcting feedback loop mentioned in the script?

The negative self-correcting feedback loop refers to the scenario where a decrease in American imports into China might reduce the demand for dollars, shifting the supply curve of Yuan to the left, and an increase in Chinese imports into the US might increase the demand for Yuan, shifting the demand curve to the right, potentially helping the Yuan appreciate.

How can changes in interest rates affect exchange rates and trade?

Changes in interest rates can affect exchange rates by influencing the demand for a country's currency. For example, higher interest rates in the US might make holding dollars more attractive, increasing demand for dollars and potentially depreciating the Chinese Yuan, which in turn affects trade by making American goods less competitive in China and Chinese goods more competitive in the US.

What is the potential effect of increased US government borrowing on exchange rates and trade?

Increased US government borrowing can lead to higher interest rates, which might attract more foreign investment in dollars, increasing demand for dollars and potentially depreciating the Chinese Yuan. This could make American goods more expensive and less competitive in China, while making Chinese goods cheaper and more competitive in the US.

How might changes in the demand curve for the Chinese Yuan affect its exchange rate with the US dollar?

If the demand for the Chinese Yuan decreases (demand curve shifts to the left), it could lead to a depreciation of the Yuan as fewer dollars are needed to purchase the same amount of Yuan. Conversely, an increase in demand for Yuan (demand curve shifts to the right) could lead to an appreciation of the Yuan.

Outlines

00:00

🌐 Exchange Rates and Trade Dynamics

This paragraph discusses the impact of exchange rate fluctuations, specifically the depreciation of the Chinese Yuan against the US dollar, on trade. It uses a supply and demand framework to illustrate how changes in the exchange rate affect the equilibrium. The narrator explains that a depreciation can occur if the demand for Yuan decreases or the supply of Yuan increases. The example of General Motors is used to show how a depreciation makes American goods more expensive for Chinese consumers, potentially leading to a decrease in American imports to China. Conversely, Chinese goods become cheaper for American consumers, which could increase Chinese imports to the US.

05:06

🔄 Self-Correcting Feedback Loops in Currency Exchange

The second paragraph delves into the potential self-correcting mechanisms in currency exchange markets. It suggests that a decrease in American imports to China could lead to less demand for US dollars, potentially causing the Yuan to appreciate. Similarly, an increase in Chinese imports to the US could lead to a higher demand for Yuan, also contributing to its appreciation. The paragraph also explores how changes in interest rates, influenced by factors like government borrowing, can affect currency exchange rates. Higher interest rates in the US could make holding dollars more attractive, leading to a depreciation of the Yuan, which in turn could affect trade by making American goods less competitive in China and Chinese goods more competitive in the US.

Keywords

💡Exchange Rates

Exchange rates are the values at which one currency can be exchanged for another. They play a crucial role in international trade, affecting the cost of imported and exported goods. In the video, the narrator discusses how changes in exchange rates, specifically the depreciation of the Chinese Yuan against the US dollar, can impact trade dynamics. For instance, a depreciation makes Chinese goods cheaper for US buyers but makes US goods more expensive for Chinese consumers.

💡Depreciation

Depreciation, in the context of currency, refers to a decrease in the value of one currency relative to another. The video script uses the example of the Chinese Yuan depreciating against the US dollar, which means it takes more Yuan to buy one US dollar. This depreciation can make a country's exports more competitive abroad because they are cheaper for foreign buyers, but it can also make imports more expensive for domestic consumers.

💡Supply and Demand

Supply and demand are fundamental economic concepts that determine the price of a product or service in a market. In the video, the narrator visualizes the exchange market for the Chinese Yuan using supply and demand curves. The supply curve represents the willingness of people holding Yuan to exchange them for dollars, while the demand curve represents the interest of dollar holders in acquiring Yuan. The equilibrium point where supply meets demand determines the exchange rate.

💡Equilibrium Exchange Rate

The equilibrium exchange rate is the rate at which the supply of a currency equals its demand, resulting in a balance with no surplus or shortage. In the script, the narrator refers to an initial equilibrium exchange rate (E sub 1) and how it changes to a new equilibrium (E sub 2) when the supply of Yuan increases, leading to depreciation. This concept is central to understanding how shifts in supply and demand can affect exchange rates.

💡Shift in Supply

A shift in supply refers to a change in the quantity of a good or service that producers are willing to supply at each price level. In the video, the narrator explains that the depreciation of the Yuan could be caused by a shift to the right in the supply curve, indicating that holders of Yuan are more interested in exchanging them for dollars, which can lead to a depreciation of the Yuan.

💡Shift in Demand

A shift in demand occurs when there is a change in the desire or ability of consumers to purchase a good or service at each price level. The video script mentions that if the demand for Yuan shifts to the left, it means that dollar holders are less interested in acquiring Yuan, which can also lead to depreciation.

💡Trade

Trade, as discussed in the video, refers to the exchange of goods and services between countries. The narrator explores how changes in exchange rates can affect trade by altering the relative prices of imported and exported goods. For example, a depreciated Yuan makes American goods more expensive for Chinese consumers, potentially reducing American imports into China.

💡Imports and Exports

Imports are goods or services brought into a country from abroad, while exports are those sent out. The video script uses the concept of imports and exports to illustrate how exchange rate changes can impact a country's trade balance. If the Yuan depreciates, Chinese exports become cheaper for US buyers, potentially increasing Chinese exports, while American imports become more expensive for Chinese consumers, potentially decreasing imports.

💡Interest Rates

Interest rates are the cost of borrowing money and the return on saving. In the video, the narrator discusses how changes in interest rates, particularly in the US, can affect the demand for dollars and, consequently, exchange rates. Higher interest rates in the US might make holding dollars more attractive, leading to an increase in demand for dollars and potentially affecting the Yuan's value.

💡Government Borrowing

Government borrowing refers to when a government issues debt to finance its spending. The video script mentions that increased government borrowing in the US could lead to higher interest rates, which might attract more foreign investment and increase the demand for dollars. This, in turn, could affect the exchange rate between the Yuan and the dollar, impacting trade.

💡Self-Correcting Feedback Loop

A self-correcting feedback loop is a process where the outcome of a system's behavior influences the system in a way that corrects or counteracts the initial behavior. In the context of the video, the narrator suggests that if American imports to China decrease due to a depreciated Yuan, this might reduce the demand for dollars by Chinese consumers, potentially leading to an appreciation of the Yuan and a return towards equilibrium.

Highlights

Exchange rates can affect trade by influencing the cost of goods between countries.

The Chinese Yuan depreciation against the US dollar can be visualized through supply and demand curves for the Yuan.

An equilibrium exchange rate is established where the supply and demand for a currency balance.

Depreciation of the Yuan can occur if the demand for Yuan decreases or the supply of Yuan increases.

A shift in the supply curve to the right represents an increase in the willingness to exchange Yuan for dollars.

Depreciation leads to a new equilibrium exchange rate with a higher quantity of Yuan per dollar.

American goods become more expensive for Chinese consumers when the Yuan depreciates.

The cost of American goods in China increases, potentially leading to a decrease in demand for these imports.

Conversely, Chinese goods become cheaper for American consumers, potentially increasing demand for Chinese imports.

A negative feedback loop may occur where changes in trade affect the supply and demand for currencies.

Government borrowing and interest rates can influence exchange rates and, consequently, trade.

Increased US interest rates can attract more Yuan holders to convert to dollars, depreciating the Yuan.

Higher interest rates in the US might lead to a shift in the demand curve for the Yuan.

The video discusses the interconnectedness of exchange rates, government policies, and international trade.

Understanding the dynamics of currency exchange rates is crucial for predicting trade patterns.

Transcripts

- [Narrator] What I wanna do in this video is

think about how exchange rates can affect trade,

and actually we can even think a little bit about

how they might be able to affect each other,

although we'll go into a lot more depth in that

in future videos.

So let's just imagine a situation where the Chinese Yuan,

the Chinese Yuan depreciates versus the dollar,

depreciates versus the US dollar to be clear,

US dollar.

To visualize what we're talking about,

let's draw the supply and demand,

or the exchange market for the Chinese Yuan.

So our horizontal axis would be quantity,

quantity of Yuan,

and then our vertical axis would be the price of a Yuan

in terms of dollars,

so dollars per Yuan.

And we've seen this before.

This right here would be the supply of Yuan,

so these would be the people who are holding Yuan

but might be willing to exchange them into dollars,

and then this would be the demand for Yuan,

these are the people who are holding dollars

who might be interested in exchanging them for Yuan.

There will be some equilibrium exchange rate,

let's call that E sub 1,

and let's call this,

it's an equilibrium quantity per time period,

let's say call that Q sub 1.

And just to be clear, this is our supply curve for the Yuan,

and this is our demand curve for the Yuan.

So a situation where the Chinese Yuan depreciates

versus the dollar.

There is two ways really that that could happen.

One, you could have the demand for the Yuan

shift to the left, or you could have the supply of Yuan

shift to the right.

The demand shifting to the left would mean for some reason

people who hold dollars are less interested in getting Yuan,

and supply shifting to the right would mean

people who hold Yuan are all of a sudden

more interested in getting dollars.

So let's just do the latter one.

So let's say the supply shifts to the right.

I just want a scenario where we have

the Chinese Yuan depreciating against the US dollar.

And so you see very clearly in this world,

if our demand does not shift,

we get to this next equilibrium exchange rate, E sub 2,

and there's also a different equilibrium quantity.

But you can see the Chinese Yuan has depreciated

versus the dollar.

If E sub 1, maybe E sub 1 is 15 cents per Chinese Yuan,

and maybe E sub 2 is 10 cents per Chinese Yuan.

But now that we understand

and we can visualize what we're talking about,

what would be the impact on trade.

I'm gonna think about it in two ways.

What is going to happen in China,

let's think about China first.

So in China, or we're gonna be thinking about

the Chinese consumers.

Well Chinese consumers, they hold Yuan,

and they might buy some American goods.

What would happen to the cost of those American goods?

Well assuming that the American suppliers

offer their products in a fixed dollar price, so let's say

you are General Motors, an American car company,

and there's a car that's manufactured in the United States

and it costs $20,000.

Well in a world where the Chinese Yuan depreciates

versus the dollar, the amount of Yuan to equal

20,000 US dollars has now increased.

You need more Yuan per dollar,

because you're in a world where there is

fewer dollars per Yuan.

So American goods,

American goods,

more expensive in China,

expensive in China.

And so what might that do to the behavior,

how might people decide to trade off between

American and Chinese, let's say in this example, cars.

Well if American goods, and in this example, cars

become relatively more expensive,

then they're likely to buy fewer American cars.

So if we're talking about all American products,

we could say American,

American imports into China,

into China,

will go down, because they're going to be

relatively more expensive.

Now what about in the United States,

in the United States,

what is going to happen.

Well, assuming the Chinese goods are offered by the supplier

at a fixed Yuan price,

well now you need fewer dollars per Yuan.

So Chinese goods,

Chinese goods,

are going to be less expensive,

less expensive,

to American buyers,

so less expensive in the US,

'cause each dollar is gonna buy more Yuan

and assuming that the goods all have a fixed price in Yuan,

and so you could say Chinese imports into,

imports into the US are going to go up.

And what's interesting is that you might have

a little bit of a negative self-correcting feedback loop,

because what's likely to happen if

American imports into China go down.

Well that means that fewer Chinese folks are going to be

interested in converting their Yuan into US dollars

in order to buy goods,

because they're not buying as many American goods,

and so that might have the effect of

shifting the supply curve back to the left.

Similarly, in a world where

Chinese imports to the United States go up,

well now all of a sudden more Americans will be

interested in converting their dollars into Yuan,

and so that might shift the demand curve to the right.

So that might, either of these could have the effect of

maybe helping the Chinese Yuan appreciate a bit.

Now in previous videos, we've talked about

many factors that could shift the supply or demand curve

for a currency to the right or left,

but it would be interesting to think about

what would be the effects of interest rate changes

in each country.

Now we can link it not just to

what would happen to the supply and demand curve,

but we could think about how that might affect trade.

Let's imagine a situation where the US government,

government, increases borrowing,

and we've talked about this in previous videos.

That will likely lead to increased interest rates,

'cause you have a big borrower here,

you could even have a crowding out effect

because of the increased interest rates,

fewer private borrowers in the US might borrow,

but this would increase likely, doesn't always,

increase interest rates,

interest rates,

in the US.

Now if you have increased rates in the US,

what might happen for folks in China.

Well they might say hey,

we are more interested in holding dollars 'cause we could,

in a dollar bank account,

all of a sudden we get more interest.

So that could have the effect that we saw earlier,

where it could say,

hey more Yuan holders are interested in

converting into the US dollars,

so it would shift the supply of Yuan to the right,

which would have the impact of

depreciating the Chinese Yuan,

which is where we started this video.

So you could see something like the US government borrowing,

which increases interest rates,

could actually have an impact on trade.

It could actually make American goods

less competitive in China,

and Chinese goods more competitive in the United States.

And I just did a scenario where the supply curve

shifts to the right,

but you could also imagine a situation where

government borrowing increasing

the interest rate in the United States

could even change the demand curve.

Remember, the demand curve's gonna be determined by

the sentiment from dollar holders,

and how much they wanna convert to the Yuan.

But if interest rates in the United States go up,

well now they might say hey,

I might wanna save in the United States as opposed to

investing in China or converting my money to Yuan,

and saving in Chinese bank accounts.

So I'll leave you there.

The big thing to appreciate here is that

exchange rates and trade are very linked,

and that things like government borrowing

can affect interest rates,

which can affect exchange rates,

which can affect trade.