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

that wants to use the euros to buy European goods and import those
goods back into the United States. Third, it could lend the euros to a
European borrower. To simplify the discussion, we will imagine that no
one in Europe would lend to anyone in America, and no one in America
would lend to anyone in Europe. Foreign borrowing and lending will be
considered separately.
A European firm that sells goods in the United States will find itself
in a similar position. The firm will receive U.S. dollars, and it could try
to convert them into euros or sell them to a European importer who needs
them to buy American goods for import back into Europe. In a situation
in which some parties (U.S. exporters and European importers) want to
trade euros for dollars, while others (U.S. importers and European
exporters) wish to trade dollars for euros, mutually beneficial exchanges
are clearly possible.
Figure 34.2 illustrates the market for foreign exchange (dollars and
euros in our two-currency example). The supply curve for dollars is determined
by U.S. importers who want to sell dollars to buy the euros they
need and by European exporters who want to sell the dollars they have
earned. At a low value of the dollar, such as e 1 , U.S. imports (European
exports) will be low because dollars buy few euros. From the perspective
of Americans, European goods are expensive—it takes many dollars to
purchase European goods. At a high value of the dollar, such as e 2 , U.S. imports
(European exports) will be high because, from the perspective of Americans, European
goods are cheap. Thus, the supply curve of dollars in the foreign exchange market
slopes up.
The demand curve for dollars is determined by U.S. exporters who want to sell the
euros they have earned and buy dollars and by European importers who want to buy
dollars to purchase American goods. At a low value of the dollar, such as e 1 , U.S.
exports (European imports) will be high because a euro buys many dollars. From the
perspective of Europeans, American goods are cheap. At a high value of the dollar, such
as e 2 , U.S. exports (European imports) will be low because, from the perspective of
Europeans, American goods are expensive. Thus, the demand curve of dollars in the
foreign exchange market slopes down. The value of the dollar at which the demand
for dollars equals the supply of dollars is the equilibrium exchange rate—in the figure,
this point is e 0 —where exports and imports are equal. As we will see, exports and
imports need not be equal once we take foreign borrowing and lending into account.
We can use the demand and supply model of the foreign exchange market to
analyze how the equilibrium exchange rate is affected when other factors change
and shift the demand or supply curves. For example, suppose Americans adopt a
“buy American” campaign that reduces the demand for European imports at each
value of the exchange rate. We can represent the impact of this campaign by a leftward
shift in the supply curve of dollars as U.S. imports (European exports) fall, as
illustrated in Figure 34.3. The equilibrium exchange rate rises. When the dollar rises
in value relative to other currencies, we say that the dollar appreciates. Because
the higher value of the dollar makes U.S. goods more expensive for foreigners, U.S.
exports fall. In the new equilibrium, both U.S. imports and exports have fallen by
the same amount, since exports equal imports in equilibrium. A “buy American”
EXCHANGE RATE = EURO/U.S. DOLLAR (e)
e 2
e 0
e 1
Figure 34.2
Supply curve
for dollars
Demand curve
for dollars
U.S. DOLLARS
THE EQUILIBRIUM EXCHANGE RATE
At the exchange rate e 2 , supply exceeds demand. At
e 1 , demand exceeds supply. At e 0 equilibrium is
achieved.
DETERMINING THE EXCHANGE RATE ∂ 761