2. Analyzing a foreign exchange market A key simplification in thinking about in

Question

2. Analyzing a foreign exchange market A key simplification in thinking about international trade is to work with only two countries. In this case, we are focusing on the United States and Japan, whose respective currencies are the dollar and the yen. The intuition you get from a two-country model almost always guides you to the correct answer for a more complicated world. So the foreign exchange market here is the market in which people exchange dollars for yen and vice versa. In a foreign exchange market, it is not obvious who is buying and selling. For example, in the yen-dollar market, anyone who is buying yen is selling dollars. Taking the scenario just introduced, consider the two general types of participants in the foreign exchange market. Exporters want to convert the foreign currency they receive from sales abroad into their home currency. This represents the Investors in one country who want to buy an asset such as a government bond from someone in a foreign country need foreign currency. currency to make the purchase. This represents the foreign currency.

Explanation / Answer

Exporters want to convert the foreign currency they receive from sales abroad into their home currency. This represents the supply of foreign currency. (They want to sell the foreign currency and buy the home currency)

Investors in one country who want to buy an asset such as a government bond from someone in a foreign country need foreign currency to make the purchase. This represents the demand for foreign currency. (They want to buy the foreign currency and sell the home currency)

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