Exchange Rates

The exchange rate is the most important price in economics because it affects all other prices. Most products we buy are made in other countries. For example, the TV’s you buy are most likely made in Japan, and most of the toys we buy are made in China. When you spend your money on a Japanese TV, the dollars are exchanged for yen somewhere along the way to pay the Japanese workers who build the TV.

The exchange rate is determined by supply and demand. If the demand for yen exceeds the supply at the current exchange rate, the cost of yen in terms of dollars will increase, and if supply exceeds demand, it will fall.
People also seek to acquire foreign currency to make investments. If America’s interest rates are higher than Japan’s, then Japanese investors will likely want to buy our bonds to take advantage of those higher rates. But to do so, they must first sell yen and buy dollars. It is a tricky situation.

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