If a ten year old asks you why a US Dollar costs 63.2 INR, how should you explain it?
Something in line with the following conversation should help in explaining the concept to him. :)
Y: You, C: Child
Ask the 10 year old: "If you had only 10 rupee notes, and wanted to buy a chocolate of Rs. 20 what would you do?"
Child will say - "Give the shopkeeper 2 notes"
Y: "Let's go to another shop. What would you do if a better chocolate costs Rs. 50 there?"
C: "I will give shopkeeper 5 notes"
Y: "Good, There's another shop called XYZ which sells the best chocolate at Rs. 500 and accepts nothing but Rs. 100 notes. It is indeed an awesome chocolate that you will really like. What would you do then?"
C: "Give him 50 notes"
Y: "Remember the shopkeeper accepts only Rs. 100 notes?'"
C: "But I will give him the same amount of money!!"
Y: "But he uses a different system, he runs his shop only on 100 Rupee notes. But you have only 10 rupee notes. Are they of any value if you want to do business with the shop?"
C: "No. I might have to take 5*100 rupee notes from someone and give him 50 notes in return"
Y: "Good!! Let us say a man is standing outside the shop offering 100 rupee notes in exchange for 10 rupee notes..then?"
C: "Wow!! I will give 50 notes to him, and take 5*100-rupee notes"
Y: What if the person says 'Everybody seems to like the chocolate here. Everybody wants 100 rupee notes. I want 60 notes for 5*100 notes'.
Now C starts thinking.
Y: You really want the chocolate. Meanwhile another person comes and tries to buy his 100 rupee notes. If you do not buy his note quickly - he might ask for even more notes because, many people want to buy his notes
Y: "Did the value of the chocolate change?"
C: "No"
Y: "Did you have less money?"
C: "No"
Y: "Then what was the problem?"
C: "The shopkeeper wants only 100 Rupee notes!!! :( "
Y: "But finally did you end up paying more than 500 rupees for a 500 rupee chocolate?"
C: "yes!!! :("
Y: "Why? The chocolate price never changed!"
C: "The chocolate price remained the same. But the price of the 100 rupee note was more!!! :( "
Y: "That is what happens. The shop is USA. Lets call the 100 rupee note as the Dollar. Other shops are India. They accept your 10 rupee note. The 'value' lies in the thing. Money is just a medium of exchange. So its value comes from its 'level of acceptance' by people. The chocolate is the same value, but is available only in USA. If you want to do business with him, you need to give him whatever note he wants. He accepts only Dollars. Your 10 rupee note has no value - although you have as many as you want. So you have to go to somebody who has dollars. When you buy the dollar, the price depends on how high the demand for the dollar is. It has nothing to do with the actual value of the chocolate you are buying. What happens if more and more people want the dollar?"
C: "I will have to pay more and more rupees for the same dollar" (Exchange rate)
You end with: "So when we say $1 is equal to INR 60, it means that everybody wants to buy dollars. Actually, if you want to do business with any FOREIGN country, the rule is that you should use dollars. So the price has become very high. You have to pay 60 rupees to just buy 1 dollar."
This will explain the exchange rate, forex trading and the dollar standard concepts. But the curiosity might continue....
C: "OK, but why should everybody use the dollar? What if somebody is OK to take my 10 rupee note?"
Y: "Then ugly things happen. You will understand only when you grow up"
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