[youtube https://www.youtube.com/watch?v=EH4g3qbc_vo&w=560&h=315]

– [Instructor] In a previous video, we've given an intuition on what foreign exchangemarkets are all about.

In particular, we talked aboutthe foreign exchange market between the U.

S.

dollarand the Chinese yuan.

What we're going to doin this video is think about the same idea, but thinkabout it in terms of graphs and the types of economicmodels that we're used to seeing in an introductory macroeconomics course.

So what we're going tofocus on in this video is the foreign exchange market.

Foreign exchange market for the Chinese yuan.

Now, we're going to think about it in terms of supply and demand curves.

It can be a little bit confusing because we're gonna be thinkingof the price of the yuan in terms of another currency,in this case the dollar, although you could do it interms of other currencies, the pound or the euro or whatever else.

Now, this can be a little bit confusing because we're going to be thinking about currency on both axes.

But let's first thinkabout the horizontal axis that when we're thinkingabout most markets, that is our quantity axis.

And here once we're goingto think about quantity.

We're gonna think about the quantity.

Quantity of Chinese yuan.

And then our vertical axis, we're essentially going tobe thinking about the price of the Chinese yuan.

But how do you think aboutthe price of a currency? Well, we're going to think of it in terms of another currency.

And for the sake of this video, that other currency isgoing to be the U.

S.

dollar.

So this is going to be U.

S.

dollars per Chinese yuan.

And I encourage you, pause this video.

Think deeply about why it'sU.

S.

dollars per Chinese yuan, as opposed to Chineseyuan per U.

S.

dollars.

And think about why I put thequantity of Chinese yuan here instead of the quantity of U.

S.

dollars, because this is theforeign exchange market for the Chinese yuan.

I could have done another chart where it's the foreign exchangemarket for the U.

S.

dollar, in which case then myquantity would be U.

S.

dollar.

And then I would think of how much of some other currency per U.

S.

dollar.

So I would say maybe how muchChinese yuan per U.

S.

dollar? But here it's the other way around.

I'm in the market for the Chinese yuan.

So let's think about thesupply and demand curves and which way they would work.

Well, imagine that people areoffering very few U.

S.

dollars per Chinese yuan.

Well, in that world, a lot ofpeople might not wanna convert their yuan into dollars.

They might not offer them up for supply to be converted into U.

S.

dollars.

The quantity of Chinese yuan, if the price for the Chinese yuan is low, might be pretty low.

And as the price people are willing to pay in terms of dollars goes up, well, more and more peoplemight be willing to transact.

So our supply curve, and herewe're talking about the supply for Chinese yuan, is likely to increase as people are willing topay more for those yuans.

And this is like many marketsthat we've seen before.

It's just a little bit less intuitive because we're thinking aboutmarkets for one currency in terms of another currency.

Now, what about the demand curve? Well, the demand curve is gonna look like a lot of demand curves we've seen.

If the price of a Chinese yuan is high, well, very few peopleare going to demand it.

And as the price of the Chinese yuan in terms of dollars is lower and lower, more and more people mightdemand more Chinese yuan, go like, "Hey, it's cheapernow in terms of U.

S.

dollars.

" So this is what a demandcurve might look like.

And as you can imagine, this point is our equilibrium point, and it would tell us ourequilibrium exchange rate.

We could call that ourequilibrium exchange rate, and this would be ourequilibrium quantity.

So, for example, let's saythat our equilibrium quantity, and let's say this is thequantity that changes hands in some time period, so let's say per day.

Let's say or equilibriumquantity is equal to 1,000 yuan.

1,000 yuan.

And let me just call this Q sub one, is 1,000 yuan.

These numbers are very low.

Real exchange markets, wemight be talking about billions or tens or hundreds of billions or even sometimes trillionsof various currency.

But let's just say forargument it's 1,000 yuan is our current equilibriumexchange quantity per day.

And let's say thisexchange rate, e sub one, is equal to 10 cents per yuan.

So 10 cents, or 1/10 of a U.

S.

dollar per Chinese yuan.

So that's our current exchange rate.

Now, let's say for some reason, all of a sudden Americansbecome increasingly interested in converting their currency.

Maybe they want to invest in China.

Maybe all of a sudden the Chinese say, "Hey, Americans, comebuy property in China.

" A lot of people are interested.

Well, what would happen here? Well, then the demandfor yuan would increase because you could only buy thatproperty in China with yuan, not with U.

S.

dollars.

What would happen here? Well, your demand curvewould shift to the right like we've seen before.

If we call this D one, then we could get to a new demand curve that might look somethinglike this, D two.

Now, what would happen if our equilibrium exchangerate doesn't change? Well, if this is our exchange rate, if this were to stay our exchange rate, now all of a sudden a higherquantity is being demanded than is being supplied.

The Americans in this situation, or it actually doesn'teven have to be Americans.

It could just be whoever'sholding U.

S.

dollars, there's demand for morethan 1,000 yuan per day.

Maybe this is 1,500 yuanor whatever it might be.

What you would naturally seeis that price of the yuan in terms of U.

S.

dollars will go up until you get to an equilibrium point.

And on the first video whenwe talk about the intuition of foreign exchange markets, we talk about why this would be.

So you would then getto a new equilibrium, right over here, this is e sub two, and a new equilibrium quantity.

Let's call this Q two.

Our new equilibrium quantity, Q two, might be 1,200 yuan per dayversus 1,000 yuan per day.

And our new equilibrium exchange rate, maybe this is now equalto 15 cents per yuan instead of 10 cents per yuan.

So big picture, you can thinkof the foreign exchange market in a lot of ways like we've looked at other markets in macroeconomics.

It takes a little bit of an intuitive leap to just think about themarket for one currency in terms of another.

Source: Youtube