Currency Exchange
| Author | Denise Woodbury |
| Pages | 182-185 |
Page 182
Money is any medium that is universally accepted in an economy by sellers of goods and services as payment and by creditors as payment for debts. Money serves as a medium of exchange; indeed, without money, we would have to resort to barter in doing business. Barter is simply a direct exchange of goods and services for other goods and services. For instance, a wheat farmer who wants a pair of eyeglasses must find an optician who, at exactly the same time, wants a dozen bushels of wheat; that is, there must be a double coincidence of wants, and the elements of the desired trade must be of equal value. If there is not a double coincidence of wants, the wheat farmer must go through several trades in order to obtain the desired eyeglasses; for example, this might involve trading wheat for a computer, then the computer for several lamps, then the lamps for the desired eyeglasses.
The existence of money means that individuals do not need to hold a diverse collection of goods as an exchange inventory. Money allows them to specialize in any area in which they have a comparative advantage and to receive money payments for their labor. Money can then be exchanged for the fruits of other people's labor. The use of money as a medium of exchange permits individuals to specialize and promotes the economic efficiencies that result from specialization.
In the same way that money facilitates exchange in a single economy, exchange of currencies facilitates the exchange of goods and services across the boundaries of countries. For instance, when you buy a foreign product, such as a Japanese car, you have dollars with which to pay the Japanese carmaker. The Japanese carmaker, however, cannot pay workers in dollars. The workers are Japanese, they live in Japan, and they need Japanese yen to buy goods and services in that country. There must be some way of exchanging dollars for the yen that the carmaker will accept in order to facilitate trade. That exchange occurs in a foreign-exchange market, which in this case specializes in exchanging yen for dollars.
The particular exchange rate between yen and dollars that would prevail depends on the current demand for and supply of yen and dollars (see Figure 1). If one cent per yen is the equilibrium price of yen, then that is the foreign-exchange rate determined by the current demand for and supply of yen in the foreign-exchange market. A person going to the foreign-exchange market would need one hundred yen (1/.01) to buy one dollar or one dollar to buy one hundred yen.
Suppose you want to buy a Japanese car. To do so, you must have Japanese yen. You go to the foreign-exchange market or your American bank. Your desire to purchase the Japanese car causes you to...
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