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FIGURE 2 Stock Prices as Measured by the Dow Jones Industrial Average, 1950-2002

Source: Dow Jones Indexes: http://finance.yahoo.com/7u.

FIGURE 2 Stock Prices as Measured by the Dow Jones Industrial Average, 1950-2002

Source: Dow Jones Indexes: http://finance.yahoo.com/7u.

What have these fluctuations in the exchange rate meant to the American public and businesses? A change in the exchange rate has a direct effect on American consumers because it affects the cost of imports. In 2001 when the euro was worth around 85 cents, 100 euros of European goods (say, French wine) cost $85. When the dollar subsequently weakened, raising the cost of a euro near $1, the same 100 euros of wine now cost $100. Thus a weaker dollar leads to more expensive foreign goods, makes vacationing abroad more expensive, and raises the cost of indulging your desire for imported delicacies. When the value of the dollar drops, Americans will decrease their purchases of foreign goods and increase their consumption of domestic goods (such as travel in the United States or American-made wine).

Conversely, a strong dollar means that U.S. goods exported abroad will cost more in foreign countries, and hence foreigners will buy fewer of them. Exports of steel, for example, declined sharply when the dollar strengthened in the 1980-1985 and

Index

Index

FIGURE 3 Exchange Rate of the U.S. Dollar, 1970-2002

Source: Federal Reserve: www.federalreserve.gov/releases/H10/summary.

FIGURE 3 Exchange Rate of the U.S. Dollar, 1970-2002

Source: Federal Reserve: www.federalreserve.gov/releases/H10/summary.

1995-2001 periods. A strong dollar benefited American consumers by making foreign goods cheaper but hurt American businesses and eliminated some jobs by cutting both domestic and foreign sales of their products. The decline in the value of the dollar from 1985 to 1995 and 2001 to 2002 had the opposite effect: It made foreign goods more expensive, but made American businesses more competitive. Fluctuations in the foreign exchange markets have major consequences for the American economy.

In Chapter 19 we study how exchange rates are determined in the foreign exchange market in which dollars are bought and sold for foreign currencies.

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