Question

Under a gold standard, if the price of an ounce of gold is 1,400 U.S. dollars and 1,300 Canadian dollars, what is the exchange rate between U.S. and Canadian dollars?

Short answer

Answer: The exchange rate is 1.4 U.S. dollars per 1 Canadian dollar under the gold standard.

Step-by-step solution

Understand the given information

We are given the price of an ounce of gold in U.S. dollars (1,400) and Canadian dollars (1,300).

Set up a proportion

To find the exchange rate between U.S. dollars (USD) and Canadian dollars (CAD), we will set up a proportion using the gold prices given: (USD/Gold) : (CAD/Gold) = (USD/CAD)

Plug in the given values

Now, plug in the given values for the price of gold in U.S. dollars and Canadian dollars: (1400 USD/Gold) : (1300 CAD/Gold) = (USD/CAD)

Simplify the proportion

Simplify the proportion by multiplying both sides by 1300 to get the exchange rate (USD/CAD): (1400 USD/Gold) * (1300 CAD/Gold) = (1300 USD/CAD) * (1300 CAD/Gold) 1820000 USD CAD / Gold^2 = (1300 USD/CAD) * (1300 CAD) Now, divide by 1300 CAD: 1400 USD = (1300/1300) USD/CAD

Determine the exchange rate

The resulting simplified proportion gives us the exchange rate between U.S. dollars and Canadian dollars: 1.4 USD = 1 CAD The exchange rate is 1.4 U.S. dollars per 1 Canadian dollar under the gold standard.

Key concepts

Currency Exchange

Currency exchange is a fundamental concept in international economics that allows currencies to be traded for one another. This mechanism enables countries to participate in global trade by using different currencies in transactions. When traveling, for instance, exchanging your home currency for the local currency becomes necessary to make purchases.

Each currency has a value determined by various factors, including economic stability, inflation, and political conditions. Exchange rates can fluctuate based on supply and demand in global markets. Moreover, different methods are used to determine these rates, such as under a fixed system like the gold standard or a floating rate driven by the market forces. Currency exchange facilitates international business by providing a common platform for currency valuation.

Gold Standard

The gold standard is a monetary system where a country’s currency value is directly linked to gold. Under this system, currency notes can be exchanged for a certain amount of gold, giving them tangible value. Historically, this ensured economic stability as the value of currency was not arbitrarily set but pegged to a known value of gold.

Countries operating under the gold standard could engage in international trade more predictably, as exchange rates were relatively stable. For example, if an ounce of gold costs 1,400 USD and 1,300 CAD, it implies that the exchange rates are set based on these gold prices. Though the gold standard assured consistency, it limited monetary policy flexibility, leading many countries to eventually move to other systems.

Proportion Method

The proportion method is instrumental in determining exchange rates under a gold standard. This method involves setting up a ratio or proportion between two currencies based on their respective gold values.

To use this method, you first identify the gold prices for each currency. Then, set up the proportion as follows:

• (Currency1/Gold): (Currency2/Gold) = (Currency1/Currency2)

For instance, if an ounce of gold is priced at 1,400 USD and 1,300 CAD, the exchange rate set-up will look like this:

• (1400 USD/Gold): (1300 CAD/Gold) = (USD/CAD)

Through simplification, we derive that 1.4 USD equals 1 CAD, providing a clear exchange rate using known values.

International Economics

International economics studies how countries interact economically, emphasizing global trade and finance. A key aspect includes understanding how currency exchange affects trade balances, investments, and economic growth.

Under systems like the gold standard, international economics becomes more predictable since exchange rates are fixed and established by gold parity. However, this also comes with constraints on adjusting currency value to accommodate inflation or other economic shifts.

In today’s global economy, exchange rates mostly float freely, driven by market dynamics. However, understanding historical frameworks like the gold standard helps scholars and economists appreciate the evolution of financial systems and their impact on trade and policy.