Today, we're looking at two different applications of supply and demand: Currency Exchange, and Excise Taxes!
CURRENCY EXCHANGE:
The exchange rate is the price of a foreign currency in terms of a domestic currency. For an example, if 1 Canadian Dollar is Worth 2 British Pounds, the exchange rate of the British Pound is 2 Canadian Dollars.
The external value is the price of a domestic currency in terms of a foreign currency. For an example, if 1 Canadian Dollar is Worth 2 British Pounds, the external value of the Canadian Dollar is half a British Pound.
A good way to remember this is to remember that external value is 'all about me', so it's all about how much MY money is worth.
It's important to note that many major news sources don't always use these terms correctly.
OKAY! So why would people want to exchange currencies in the first place???
WELL, there two reasons.
1: They have a demand for foreign goods (so they need to convert their own currency into foreign currency in order to purchase them)
2: They want to make investments in foreign markets
SO...
Because of this, demand and supply of certain currencies depend on two factors.
DEMAND for a domestic currency depends on:
1- Demand for domestic exports
2- Foreign investment in domestic markets (K inflow)
SUPPLY of a domestic currency depends on:
1- Demand for foreign imports
2- Domestic investment in foreign markets (K outflow)
Let's say we're exchanging Canadian dollars for any kind of foreign currency. If the demand for Canadian dollars = the supply of Canadian dollars, we have EQUILIBRIUM
Things that can effect our dollar value:
-An increase in demand for Canadian goods
-A decrease in our own demand for foreign goods (in other words, a decrease in the supply of the Canadian dollar).
In this way, trade affects the currency market.
EXCISE TAXES: Basically, a sales tax which only applies to a specific item (carbon taxes, or sin taxes are examples of excise taxes)
There are two different kinds of excise taxes!
1: "AD VALOREM" ---> A percentage of the value of the product (like jewelry, slot machines, and matches)
2: "SPECIFIC" -------> A per-unit tax (quantity based) (like beer and cigarettes)
Also governments are considering creating an excise tax for fast food or trans fats... which could be interesting. The question is, does this tax serve as an effective disincentive?
TAX INCIDENCE is on whom the ultimate burden of a tax lies (aka: what percentage of the tax is paid for by consumers in the form of increased prices, and what percentage is paid for by the producer in the form of lost profits)
Basically, if you want to graphically introduce an excise tax, make a new supply curve above the original supply curve by the number of price units equal to the excise tax. Using this new curve, find the new equilibrium (where it intersects with demand at this new price). At this new quantity, the difference between the equilibrium price and the consumer price determines the consumer tax incidence, and the difference between the equilibrium price and the producer price determines the consumer tax incidence.
You can also manipulate the formulas for the curves using simple addition on the supply curve equal to the tax increase.
As a good rule of thumb, whichever curve (supply or demand) which is more inelastic will bear the majority of the tax incidence.
HOKAY! WHAT HAVE WE LEARNED SO FAR!?
Government intervention has a cost! It requires alternative allocation mechanisms, and generally the free market is much more efficient.
The free market can be a cruel cruel place...
but goddammit, it works!
An excise tax functions like an effect cost increase, and as such, it shifts the supply curve left for any product.
The consumer price = the producer price + the tax
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