McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. USING SUPPLY AND DEMAND 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 countrys 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 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 Euro Supply and Demand 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. $0.85 Quantity of Euros S D Price of euros in dollars

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. Americans buy more European financial assets and demand for euros. The price of euros Increases to $1.30. $0.85 Quantity of Euros S0S0 D0D0 S1S1 D1D1 $1.30 Price of euros

McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 5-7 $500 Shortage Price Ceilings: Rent Controls New York City has rent controls Rent control cause housing shortages Increase demand Reduce supply Rent controls also cause strange behaviors QSQS QDQD S D Rent per Month Quantity of apartments $2,000

McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 5-8 Price Floors: Minimum Wage The U.S. government has established a minimum wage that firms can legally pay. A minimum wage, W min, above the equilibrium wage, W e, Helps those who are employed, Q 2, Hurts those who would have been employed at W e, but can no longer find employment, Q e - Q 2. W min WeWe Q2Q2 QeQe Q1Q1 S D Quantity of Workers Wage per hour

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 Excise Tax on Luxury Boats Quantity of luxury boats 0 Price of luxury boats 65, S1S1 D S0S0 A $10,000 excise tax shifts the supply curve up by $10, , $70, The result of the tax is to reduce equilibrium quantity of boats by 90 units. Increase equilibrium price by less than $10,000.

McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved Quantity Restrictions In 1937 New York City limited the number of taxi licenses to 12,000 to increase the wages of taxi drivers. 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 Today, medallions sell for $400,000!

McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. What Would be the Impact of Legalizing Marijuana? 5-12