relationship between the internal value of money and the external value of money

Links Between Macroeconomic Problems and Their Interrelatedness

1️⃣ Internal vs. External Value of Money

💰 Internal value (also called purchasing power) is how much goods and services a unit of money can buy inside a country.

🌍 External value is how much foreign goods or services that same unit of money can buy when it is exchanged abroad.

Think of money as a ticket to a movie. Inside the cinema, the ticket lets you sit in a seat (internal value). If you take the ticket to a different cinema in another country, the ticket might not be accepted, or it might let you sit in a cheaper seat (external value). The price of the ticket can change depending on how many people want to see the movie (inflation) or how the cinema is doing financially (exchange rate).

2️⃣ How Internal Value Affects External Value

  1. When a country experiences inflation, the internal value of its currency falls because each unit buys fewer goods.

  2. Lower internal value usually leads to a depreciation of the currency on foreign exchange markets, reducing its external value.

  3. Example: If the UK inflation rate rises to 5 %, the pound may weaken against the euro, so a £1 can buy less than before in Europe.

3️⃣ How External Value Affects Internal Value

  1. A strong external value (appreciated currency) makes imports cheaper, which can reduce domestic price levels and help control inflation.

  2. However, a strong currency can hurt exports because foreign buyers find domestic goods more expensive, potentially raising unemployment in export sectors.

  3. Example: When the Japanese yen strengthens, Japanese cars become more expensive overseas, which can reduce sales and job numbers in the automotive industry.

4️⃣ Interrelated Macroeconomic Problems

ProblemKey VariableLink to Money Value
InflationPrice level ↑↓ Internal value → ↓ External value (depreciation)
UnemploymentJob loss ↑↓ Demand for imports → ↑ External value (appreciation)
Balance of PaymentsCurrent account deficit ↑↓ External value → ↓ Internal value (inflationary pressure)
Interest RatesRate ↑↑ External value (attracts foreign capital) → ↓ Internal value (higher borrowing costs)

5️⃣ Visualising the Relationship

\$\text{Internal Value} = \frac{1}{\text{Inflation Rate}}\$


\$\text{External Value} = \text{Internal Value} \times \text{Exchange Rate}\$

📈 If inflation rises from 2 % to 4 %, internal value halves.

📉 If the exchange rate stays constant, the external value also halves, meaning the currency is now weaker abroad.

6️⃣ Quick Recap Quiz

  • What happens to the internal value of money when inflation increases? 💡

  • How does a stronger external value affect import prices? 💡

  • Why might a country experience higher unemployment when its currency appreciates? 💡

Great job! Understanding how the internal and external values of money interact helps you see why governments and central banks make the policy choices they do. Keep exploring how these concepts play out in real-world news and data. 🚀