Question

Suppose an American firm sells a large piece of machinery to a British firm for \(\$ 40,000\). Describe the flow of money in this situation. Assume the exchange rate is \(\$ 2=£ 1\).

Short answer

In this situation, the flow of money involves the conversion of £20,000 from the British firm to $40,000 using the given exchange rate ($2 = £1). The British firm then transfers the $40,000 to the American firm's bank account as payment for the machinery. Once the American firm receives the payment, the transaction is complete.

Step-by-step solution

Identify the given information

In this case, we have the following given information: 1. An American firm sells a large piece of machinery to a British firm. 2. The cost of the machinery is $40,000. 3. The exchange rate is $2 = £1.

Calculate the amount in pounds that the British firm will pay

To calculate the amount in pounds that the British firm will pay for the machinery, we need to use the given exchange rate. We know that $2 = £1, so we can use the conversion ratio to find the amount in pounds. \( Amount_{GBP} = \frac{1}{2} * Amount_{USD} \) \( Amount_{GBP} = \frac{1}{2} * 40,000 \) \( Amount_{GBP} = 20,000 \) The British firm will pay £20,000 for the machinery.

Describe the flow of money

1. The British firm will first convert £20,000 into $40,000 using the given exchange rate. This might involve contacting their bank or a currency exchange service to facilitate the transaction. 2. The British firm will then transfer the $40,000 to the American firm's bank account as payment for the machinery. This can be done using various methods such as a wire transfer, online payment services, or a direct deposit. 3. Lastly, the American firm will receive the payment of $40,000 for the sale of the machinery. Once they've received the payment, the transaction is complete. In conclusion, the flow of money in this situation involves the conversion of £20,000 from the British firm to \(40,000 and the payment of \)40,000 to the American firm as payment for the machinery.

Key concepts

International Trade

International trade is the exchange of goods and services between countries. It allows nations to utilize their resources more efficiently and provides consumers access to products not available domestically.
Trade can involve various goods, such as machinery, technological devices, or even food. In our example, the American firm's sale of machinery to the British firm is a concrete instance of international trade.

When companies from different countries engage in trade, they navigate several important processes.

• They enter agreements detailing what is being exchanged and at what price.
• They gain an understanding of the legal and regulatory requirements in both countries.
• They manage logistics, such as shipping and delivery.

If managed well, international trade can benefit both parties by fostering growth, innovation, and economic ties between nations.

Currency Conversion

Currency conversion is a vital aspect of international trade. It involves changing money from one country's currency to another's, based on the current exchange rate. Exchange rates determine how much one currency is worth in terms of another.
In our example, with the exchange rate of $2 to £1, we had to convert the machinery's cost from USD to GBP for the British firm to make the payment in their own currency.

The conversion process requires a few steps:

• First, identify the amount in the original currency, in this case, $40,000.
• Use the exchange rate to calculate the equivalent value in the target currency. Here, $40,000 USD becomes £20,000.
• This conversion often uses banks or specialized currency exchange services.

Accurate currency conversion ensures that both parties agree on the final price in their respective currencies, facilitating smooth international transactions.

Balance of Payments

The balance of payments is an economic term that reflects a country's transactions with the rest of the world. It includes imports, exports, and financial transfers, providing a comprehensive overview of a country's economic interactions globally.
When the American firm sells machinery to the British firm, it impacts both countries' balance of payments.

The main components involved in this context are:

• The current account, which records exports and imports of goods and services.
• The financial account, noting investments and financial inflows or outflows.

For the U.S., the $40,000 received for the machinery exports increases the current account surplus. Conversely, the UK will see a debit in their current account as they pay for imported machinery.
The balance of payments provides insight into a country's economic standing and its exposure or dependence on the global market.