[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

120
110
100
1983 = 100
90
80
70
60
50
1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003
Figure 26.4
THE TRADE-WEIGHTED VALUE
OF THE U.S. DOLLAR
The figure shows an index of the average exchange rate of the U.S. dollar against other
major currencies, weighted by the value of trade.
SOURCE: Federal Reserve Board.
EXCHANGE RATE = YEN/U.S. $ (e)
e e
Figure 26.5
U.S. $
EQUILIBRIUM IN THE MARKET
FOR DOLLARS
Supply
curve of
dollars
Demand
curve for
dollars
The exchange rate is the relative price of two currencies.
The equilibrium exchange rate, e e , occurs at the
intersection of the supply and demand curves for
dollars.
countries. So, for example, the U.S. dollar–Canadian dollar exchange
rate is given more weight in the measure than is the U.S. dollar–New
Zealand dollar exchange rate because the United States engages in
much more trade with Canada. Figure 26.4 shows the trade-weighted
value of the U.S. dollar.
Thus, the exchange rate is a price—the relative price of two currencies.
Like any price, the exchange rate is determined by the laws of
supply and demand. For the sake of simplicity, let’s continue to focus
on the exchange rate between the dollar and the yen (ignoring the fact
that in the world trading system, all exchange rates are interlinked).
Figure 26.5 depicts the market for dollars in terms of the exchange rate
with the yen. The exchange rate in yen per dollar is on the vertical axis,
and the quantity of U.S. dollars is on the horizontal axis. The supply
curve for dollars represents the quantity of dollars supplied by U.S.
residents to purchase Japanese goods and to make investments in
Japan. At higher exchange rates—when the dollar buys more yen—
Americans will supply larger quantities of dollars. A Japanese good
that costs 1,000 yen costs $10 when the exchange rate is 100 but only
$6.67 when the exchange rate rises to 150. Americans will therefore
wish to buy more Japanese goods as the exchange rate rises, and the
supply curve of dollars thus slopes upward to the right. The demand
578 ∂ CHAPTER 26 THE OPEN ECONOMY AT FULL EMPLOYMENT