The present macroeconomic state of the U.S. is made up of a various highly involved procedures. In this we will attempt to cover a few simple terms and concepts involving international trade and foreign exchange rates.
According to Investopedia, the foreign exchange rate is “The price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another.”(Investopedia, 2014) The process that foreign exchange rates are determined by is not any different from other market function. Supply and demand determines what prices will be for any item. Using foreign money to understand how this market works, the dollar-yen exchange rate will depend on how the demand-supply balance changes. When the demand for dollars in Japan rises and supply does not rise similarly, each dollar will cost more yen to buy. Understanding the foreign exchange rate will help one grasp how trade between the US and foreign countries affects the GDP.
First of all, Gross Domestic Product (GDP) is the representation of the total dollar value of all goods and services produced over a specific time period (Investopedia, 2014). This is the actual ‘size’ of the economy.
The best way to describe the effects of international trade to GDP is through example, using U.S. and India. The U.S. demand for Indian imports rises. This causes an increase in America’s demand for rupees. The demand for rupees increases the cost of the rupee in dollars. When the United States buys more wears from India, holding all else equal, their net wears, along with GDP and employment, will diminish. Although, the shift in the exchange rate will automatically correct this situation, because
• as the cost, in dollars, of Indian goods rises, U.S. demand for Indian imports will fall
• as the cost, in rupees, of U.S. goods to India falls, Indian demand for U.S. products will rise.
When U.S. exports to India rise (because they are cheaper), it will...