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Chapter 29: Problem 3

Why do foreign households and foreign firms demand U.S. dollars in exchange for foreign currency? Why do U.S. households and firms supply U.S. dollars in exchange for foreign currency?

Short Answer

Expert verified
Foreign households and firms demand U.S dollars for purchasing goods and services from the U.S, making investments, or because it can provide a stable store of value compared to their domestic currency. U.S households and firms supply U.S dollars in exchange for foreign currency for travel, overseas investments, or export. The demand and supply of currencies create equilibrium in the foreign exchange market.

Step by step solution

01

Understanding why foreign households and firms demand U.S dollars

Foreign households and firms require U.S. dollars for various reasons. Generally, it could be to purchase goods and services from the U.S, for investments in U.S. economic assets such as stocks, bonds, land or buildings. Also, since the U.S dollar is a globally accepted currency, foreign companies might want to hold it as it might provide a stable store of value in comparison to their domestic currency.
02

Understanding why U.S households and firms supply U.S dollars

U.S households and firms supply U.S dollars in exchange for foreign currencies primarily when they are going abroad for travel or business. Moreover, when U.S companies want to invest in foreign countries, they need foreign currencies. Lastly, U.S firms dealing with exports would accept payments in foreign currencies which they would convert into U.S dollars.
03

Conclusion

So, the demand and supply of U.S. dollars in exchange for foreign currencies by various households and firms, both domestically and abroad, depend on activities such as trade, investments, and other economic engagements. This brings a balance in the foreign exchange market through a system of floating exchange rates where currencies are traded openly and their prices vary based on demand and supply.

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