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USING SUPPLY AND DEMAND McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 5-2 The Price of a Foreign Currency • People demand a country’s currency to buy its goods, services, and assets. • The market for currencies is called the foreign exchange market • The exchange rate is the price of one currency in terms of another currency. • Rates are determined by supply and demand in the foreign exchange market. McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 5-3 Examples of Exchange Rates McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 5-4 The Euro • The 13 members of the European Union use a common currency, the euro. • The value of a euro was $0.85 in 2001. • By the early 2000s the euro had risen to $1.30 because U.S. interest rates decreased. So: Europeans bought fewer U.S. financial assets. Americans bought more European financial assets. McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 5-5 Price of euros in dollars Euro Supply and Demand • S • $0.85 Supply of euros represents people who want to sell euros and buy dollars Demand for euros represents people who want to buy euros and sell dollars. D Quantity of Euros McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 5-6 Why the euro increased in Price Europeans buy fewer U.S. financial assets and ↓supply of euros. Price of euros S1 S0 $1.30 Americans buy more European financial assets and ↑demand for euros. $0.85 D0 The price of euros Increases to $1.30. D1 Quantity of Euros McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 5-7 Price Ceilings: Rent Controls • New York City has rent controls • Rent control cause housing shortages Increase demand Reduce supply Rent per Month S $2,000 Shortage $500 D • Rent controls also cause strange behaviors QS QD Quantity of apartments McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 5-8 Price Floors: Minimum Wage S • The U.S. government has established a minimum wage that firms can legally pay. Wage per hour Wmin • A minimum wage, Wmin, above We the equilibrium wage, We, Helps those who are employed, Q2, D Hurts those who would have been employed at We, but can no longer find employment, Qe- Q2. Q2 Qe Q1 Quantity of Workers McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 5-9 Excise Taxes • An excise tax is a tax that is levied on a specific good. • Excise taxes raise prices and reduce the quantity exchanged. McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 5-10 Excise Tax on Luxury Boats Price of luxury boats D $70,000 65,000 60,000 0 McGraw-Hill/Irwin S1 A $10,000 excise tax shifts the supply curve up by $10,000. S0 The result of the tax is to reduce equilibrium quantity of boats by 90 units. Increase equilibrium price by less than $10,000. 420 510 600 Quantity of luxury boats Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 5-11 Quantity Restrictions In 1937 New York City limited the number of taxi licenses to 12,000 to increase the wages of taxi drivers. McGraw-Hill/Irwin Because taxi medallions were limited in supply, as demand for taxi services rose, so did the demand for medallions, increasing their price to $2500 by 1947. Today, medallions sell for $400,000! Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 5-12 What Would be the Impact of Legalizing Marijuana? McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.