Question

The change in the exchange rate affects the national balance. Suppose the relative value of the U.S. dollar has gone down recently. How would this affect the U.S. national balance and net exports? Explain this using at least 100 words with relevant economic concepts and theory.

Answer 1

The balance of trade influences currency exchange rates through its effect on the supply and demand for foreign exchange. When a country's trade account does not net to zero—that is, when exports are not equal to imports—there is relatively more supply or demand for a country's currency, which influences the price of that currency on the world market.

Currency exchange rates are quoted as relative values; the price of one currency is described in terms of another. For example, one U.S. dollar might be equal to 11 South African rand. In other words, an American business or person exchanging dollars for rand would buy 11 rand for every dollar sold, and a South African would buy $1 for every 11 rand sold.........

Four key economic concepts–scarcity, supply and demand, costs and benefits, and incentives–can help explain many decisions that humans make.

• The balance of trade impacts currency exchange rates as supply and demand can lead to an appreciation or depreciation of currencies.
• A country with a high demand for its goods tends to export more than it imports, increasing demand for its currency.
• A county that imports more than it exports will have less demand for its currency.
• Trade balances, and as a result, currencies can swing back in forth, assuming each are floating currencies.
• If one or both currencies are fixed or pegged, the currencies don’t move as easily in response to a trade imbalance.

• Scarcity explains the basic economic problem that the world has limited–or scarce–resources to meet seemingly unlimited wants, and this reality forces people to make decisions about how to allocate resources in the most efficient way.
• As a result of scarce resources, humans are constantly making choices that are determined by their costs and benefits and the incentives offered by different courses of action.

Everyone has an understanding of scarcity whether they are aware of it or not because everyone has experienced the effects of scarcity. Scarcity explains the basic economic problem that the world has limited–or scarce–resources to meet seemingly unlimited wants. This reality forces people to make decisions about how to allocate resources in the most efficient way possible so that as many needs as possible are met.

For example, there is only so much wheat grown every year. Some people want bread and some would prefer beer. Only so much of a given good can be made because of the scarcity of wheat. How do we decide how much flour should be made for bread and beer? One way to solve this problem is a market system driven by supply and demand.

Supply and Demand

A market system is driven by supply and demand. Taking the example of beer, if many people want to buy beer, the demand for beer is considered high. As a result, you can charge more for beer and make more money on average by using wheat to make beer than by using wheat to make flour.

Hypothetically, this could lead to a situation where more people start making beer and, after a few production cycles, there is so much beer on the market–the supply of beer increases–that the price of beer drops.

Although this is an extreme and overly simplified example, on a basic level, the concept of supply and demand helps to explain why last year's popular product is half the price the following year.

Costs and Benefits

The concept of costs and benefits is related to the rational expectations and rational choices of consumers. In every situation, people try to maximize their benefits while minimizing their costs.

If demand for beer is high, breweries will hire more employees to make more beer, but only if the price of beer and the amount of beer they are selling justify the additional costs of their salary and the materials needed to brew more beer. Similarly, the consumer will buy the best beer they can afford to purchase, but not, perhaps, the best-tasting beer in the store.

The concept of costs and benefits is applicable to other decisions that are not related to financial transactions. University students perform cost-benefit analyses on a daily basis by choosing to focus on certain courses that they've deemed more important for their success. Sometimes this even means cutting the time they spend studying for courses that they see as less necessary.

Although economics assumes that people are generally rational, many of the decisions that humans make are actually very emotional and do not maximize our own benefit. For example, the field of advertising preys on the tendency of humans to act non-rationally. Commercials try to activate the emotional centers of our brain and fool us into overestimating the benefits of a given item