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LESSON 2 – CLASSROOM ACTIVITIES AND SIMULATIONS:

THE EURO: CURRENCY EXCHANGE AND

TRANSACTION COSTS
Lesson Overview:
Students are given one of three types of currency and encouraged to participate in a
market for a variety of inexpensive goods. Unfortunately, stores in the market are only
open for a short time and each accepts only one type of currency. As they experience the
frustration of trying to obtain the currency for the purchases they want to make, students
explore ways to reduce these transaction costs. In round 2, the option of currency
exchange at a bank is added to the activity, and in round 3, students have the option of
trading in their money for a common currency.

Concepts
Money

Currency exchange

Exchange rates

Transaction costs

Content Standards
History Standards (from National Standards for History by the National Center for
History in the Schools)

Era 10: Contemporary United States (1968 to the Present)

Standard 1: Recent developments in foreign policy and domestic politics.

1C: The student understands major foreign policy initiatives.

Therefore, the student is able to:

 Evaluate the reformulation of foreign policy in the post-Cold War era.

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Standard 2: Economic, social, and cultural developments in Contemporary United

States.

2A: The student understands economic patterns since 1968.

Therefore, the student is able to:

 Assess the effects of international trade, transnational business organization,

and overseas competition on the economy.

Economics Standards (from Voluntary National Content Standards in Economics)

Economics Standard 5: Students will understand that: Voluntary exchange occurs only
when all participating parties expect to gain. This is true for trade among individuals or
organizations within a nation, and among individuals or organizations in different
nations.

 Students will be able to use this knowledge to: Negotiate exchanges, and
identify the gains to themselves and others. Compare the benefits and costs of
policies that alter trade barriers between nations, such as tariffs and quotas.

Economics Standard 6: Students will understand that: When individuals, regions, and
nations specialize in what they can produce at the lowest cost and then trade with others,
both production and consumption increase.

 Students will be able to use this knowledge to: Explain how they can benefit
themselves and others by developing special skills and strengths.

Benchmarks, Grade 12: At the completion of grade 12, students will know

 Transaction costs are costs (other than price) that are associated with the
purchase of a good or service. When transaction costs decrease, trade
increases.

Economics Standard 7: Students will understand that: Markets exist when buyers and
sellers interact. This interaction determines market prices and thereby allocates scarce
goods and services.

Benchmarks, Grade 12: At the completion of grade 12, students will know

 When the exchange rate between two currencies changes, the relative prices of
the goods and services traded among countries using those currencies change;
as a result, some groups gain and others lose.

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Teacher Background
The importance of transaction costs, the “hassle” costs of transacting business, is
sometimes overlooked in studying markets. Standing in line, searching for information,
making comparisons, trying to get questions answered – all are real costs and they have
enough of an impact that buyers and sellers in market economies make serious efforts to
eliminate them. While transaction costs play a role in domestic markets, they take on
even greater significance in international trade where currency exchange is necessary. In
this activity, students experience the “hassle” of transaction costs and consider the
benefits of reducing or eliminating them in markets involving international exchange.

The American history/current events connection to this lesson is the formation of the
European Union, the creation of a free trade zone, and the gradual transition to the use of
a common currency, the euro. Further, it has implications for NAFTA and for other trial
balloons in the western hemisphere – like the proposal in some Latin American countries
to adopt the U.S. dollar as official currency. The activity demonstrates to students that
one of the major benefits of joining the EU or any other trade association is the reduction
of the transaction costs that inhibit trade.

Time One class period

Materials
A variety of goods to sell in "stores" – for example:
 Several bags of small-size candy
 10 – 20 cans of cold soda
 A large number of non-food items, different kinds of "stuff": pencils, stickers,
early release passes, extra credit points, free test question answers, homework
excuses, etc.
2 sets of 2 tent signs for the stores, for example:

First round:
 Food Store: Candy – 5 yellows, Drinks – 10 yellows
 Stuff Store: Stuff – 6 blues
Last round:
 Food Store: Drinks 5 yellows / 3 euros, Drinks – 10 yellows / 6 euros
 Stuff Store: Stuff – 6 blues / 9 euros
Currencies: (see directions at top of black line masters)
 Pinks – pink paper
 Yellows – yellow paper
 Blues – blue paper
 Euros – orange, buff, etc. (different color from other three)

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Set Up Instructions
1. Determine what will be sold in the 2 stores. Items need not be elaborate or expensive,
just things that you are relatively certain students will want to purchase. The
materials list (above) includes a food category and a non-food category, but this is
only a suggestion. You could, for example, have:

 Two or more different types of candy in each store;

 One candy store and one drink store;

 A store that sells extra-credit points on the next test or homework assignment or
5-minute tardy or early release passes.

 It is ok to have a variety of items in each store, but there shouldn't be too many
choices. You don't want students to spend inordinate amounts of time
determining what to purchase – although some of this helps to increase the
frustrations of the people waiting in line.

 You do want enough variety to keep most students in the class participating in all
3 rounds. You might consider adding a different type of candy or different brand
of soft drink to the food store in each round, or selling candy only the first round
and adding drinks the second, for example.

2. Select workers for the stores. (For larger classes, have more than one seller in each
store.)

3. Set up the "stores" to one side of the classroom. Use tables large enough to spread
out the merchandise, but small enough for a single storekeeper to control. Don't
crowd the stores together, but keep them close enough that those in the shopping lines
can interact (and thus might be more inclined to trade currencies).

4. Distributing money can be time-consuming. To reduce the time, make up the money
packets ahead and ask a student to quickly hand them out while you give instructions.
 Copy and cut pages of blues, pinks, yellows, and euros. Directions regarding
color and quantity are found at the top of the black line masters.
 Make one money packet of 3-5 currency notes for each student.
 Give only yellows to 1/4 of the students.
 Give only blues to 1/4 of the students.
 Give only pinks to 1/2 of the students.
 Randomly vary the amounts of currency given to the students, so that each has 2-
5 pieces of currency. No student should have more than one type of currency
(in other words, only one color of paper notes).
 Save the euros for the last round of the activity. No student should have euros
in the first two rounds of the activity.

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 Don't skimp with the currency. Although you don't want one student to have
enough to seriously deplete your stock in the store, you do want all students to
perceive that they can participate, and enough to perceive the risk of trading
currency to be relatively low.

Procedures
1. Randomly, distribute packets of currency to students – either pinks, yellows, or blues.
(See Set Up Instructions, above.)

2. Ask for 2 student volunteers to be sellers and offer to reward the sellers with a prize
of some sort (large candy bar, extra credit points, etc.) Instruct the sellers to situate
themselves at their stores where they will find their products and tent signs indicating
prices. Make sure that sellers have some small denomination bills for change. (See
Set Up Instructions, above.)

3. Once the sellers are in place, quickly give the class the following instructions:

 The currency you have in your hand is yours.

 Anything you purchase at a store is yours – to consume or save, give away, share,
etc.

 Because there are only 2 stores and lots of customers, you may only purchase one
item at a time. After you make your purchase, you may get back in the line and
make another purchase if there's anything left when it's your turn again.

 Every time you make a purchase, you earn bonus money. Show me your
purchase in order to claim your bonus. Bonuses will be paid only in the type of
currency you had at the beginning of the game.

 Sellers may only accept the currency listed on the sign for their particular
store. If a customer wants to purchase something in the store, he must have
the right type of currency.

 Stores will be open only briefly – in 3-5minute rounds. You may shop in either
store, or both.

 (Teacher note: Extend the trading round, if necessary, long enough that students
begin to deal with the problem of not having the right currency.)

 Do not belabor the instructions or take questions. The objective is to get the
students into the selling round as quickly as possible.

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4. Announce that the stores are open. (While timing the selling round, circulate among
the students, paying bonuses of 2 or 3 additional pieces of currency to successful
purchasers and taking note of their reactions for debriefing at the end of the round. If
students try to exchange currencies, do not stop them, but do not announce this option
or facilitate it.)

5. Call time and ask all consumers to return to their seats. Discuss:

 Did everyone get what she wanted? (Post on the board the number of successful
shoppers.) Why or why not?

 Focus on students who were frustrated by not having the currency the seller
would accept. Once this problem has been identified, follow-up with questions
that help students analyze the nature of the problem.

o If students didn’t get what they wanted because they didn’t have enough
money, don’t ignore the situation, but don’t make it the focus of the
discussion. Respond to students with this complaint by acknowledging that
people have different levels of income and face different opportunity costs in
purchasing products – and then give the students more currency so that they
can make purchases in the next round. (Note that if some students have
combined their money to make a purchase, it is ok.)

 Sellers: Why wouldn’t you take their money?

o Help the sellers go beyond answering that they were instructed not to take
another currency. Typically, people want only the currency they can spend
in their own country for the products they purchase every day. Remind
students that money has no intrinsic value; it is valuable only in that it can
be exchanged for goods and services. With few exceptions, people aren’t
eager to have foreign currencies. While you may want to discuss the
exceptions — speculation, fears about the stability of a country’s
government, etc. — remember that this isn’t the focus of the lesson.

 Buyers: Did anyone manage to buy a product priced in a currency other than
what you were given? How?

o Students may have talked a friend into buying something for them.
Hopefully, some students tried to exchange currency with each other. Don’t
anticipate, however, that many students will have been successful at this.
The limited time period is prohibitive and serves to heighten the students’
frustration.

 Buyers: Why didn’t the rest of you do what the successful buyer did?

o Some buyers were successful because they happened to have the currency for
the product they wanted. Others were successful in exchanging currency,

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but most were probably unsuccessful because of the time limits and the
difficulty of searching for someone willing to make a currency exchange.
Another problem was in figuring out what the exchange rate should be once
they found someone willing to exchange. If students were able to make
private exchanges, it would be interesting to note the exchange rates and
whether they were close or greatly different, and to then ask the students
how they determined the rate of exchange.

 What do people do in the real world? What can we do to solve the problem?

o Students will recognize that people usually anticipate needing a different

currency and exchange it ahead of time at a bank or airport currency
exchange service.

6. Depending on the outcome of the first round, you may choose to designate it a
"practice" round. If students were confused about the currencies or didn't realize that
they could trade currencies with each other, you may want to "give in" to their
complaints and agree to run another round. Distribute additional currency if
necessary.

7. To prepare for the next round, you may distribute 1 - 2 additional pieces of currency
(of the same type he already has) to each student, although this is not necessary as
most students will still have money from rewards in the previous round.

8. As a result of students’ suggestions, “agree” to open a bank that will exchange

currencies.

 Ask students how you will know how many pinks or blues to exchange for how
many yellows, etc.?

o Accept a variety of answers. If students don’t suggest it themselves, help them

to see the necessity of “pricing” the currency – just as we price any other
commodity.

 Explain that exchange rates are determined in currency markets, where people bid
for the currencies they want.

o Do NOT focus on the process of setting currency exchange rates. That is

another lesson - to be taught either before or after this one. Refer to the
activity, “Foreign Currency and Foreign Exchange,” in Lesson 7 to have
students experience a currency market.

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9. Announce that you have researched the issue and based on information from the
newspaper, you are willing to offer the following exchange rates to any student who
wishes to come to your bank and exchange his or her currency.

Display the exchange rates on the overhead transparency:

For 5 Yellows, For 2 Blues, For 1 Pink,
you can buy you can buy you can buy

2 1 5 1 5 2
blues pink yellows pink yellows blues

10. Before opening the bank, make sure that the sellers still have adequate supplies of
their products and replenish their stock if necessary.
 Hire a student (with good arithmetic skills) to be the banker.

11. Announce that the selling round will again be only 3-5 minutes, and that there will,
again, be bonuses for making purchases. Open the stores and the bank. (Don't worry
if the banker works slowly and not all students are able to exchange their money in
time to make purchases; this is desirable.)

12. Close the bank, call time, and close the stores. Ask all students to return to their
seats. Distribute 1 or 2 additional pieces of currency (of the type the student originally
held) to each student.

13. Discuss:

 Did you get what you wanted this time? (Post on the board the number who got
their first choice.) Why or why not?

o Again many students probably did not get what they wanted because of time
limitations, standing in line at the bank, etc.

 Did you use the bank? Why or why not?

o Some students may have tired of the line. In addition, some who didn’t think
of it in the first round might have engaged in private currency exchanges.

 Did the bank solve the problem? Why or why not?

o The bank should have reduced the problem, especially for those at the head
of the line, but it did not eliminate the transaction cost.

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 What, exactly, is the problem?

o The problem is the hassle involved in getting the right currency to make the
purchase.

 Is it possible to solve / eliminate the problem? If so, how? If not, why not?

o Some students might recognize that it’s virtually impossible to eliminate

transaction costs, but all students should acknowledge that they could be
reduced. Hopefully, students will suggest all using the same currency.

 Which currency should we use?

o Presumably, students will want everything to be priced in the currency they

are holding, as this involves fewer hassles for them. At some point, if the
students don’t suggest it themselves, propose that you are going to settle the
dispute by creating a 4th currency.

14. Show students some “Euros” and post the exchange rate to euros for each of the three
currencies.

 Teacher Note: All the exchange ratios in this activity are fictitious. No attempt
has been made to reflect relative prices in contemporary currency markets.

For 5 Yellows, For 2 Blues, For 1 Pink,

you can buy you can buy you can buy

2 1 5 1 5 2

blues pink yellows pink yellows blues

3 euros 3 euros 3 euros

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15. Replace the store signs with dual price (home currency/euros) signs. Instruct the
sellers that they may accept either of the currencies listed on their signs.

16. Tell the student “customers” that before the next selling round, they may exchange
any or all of their currency for euros if they wish to do so. Students willing to
exchange currencies should calculate the exchange from the rates posted on the
board, so that they will be ready when you come around with the euros. Encourage
students to have neighbors check their calculations. Circulate through the room,
exchanging currency for euros (only) for any students who wish to do so.

 For simplicity, the Euro notes are all in 3's. If students don't have exact numbers
of notes, round in their favor.

17. Open the stores for the final 3-5 minute round.

18. End the round and have all students return to their seats.

Debriefing Questions
 Were there advantages to the customers of using euros? Explain.

o The hassle of purchasing was greatly reduced, especially in the stores that
didn't take your currency.

o The lines were shorter.

o It is easier to make comparisons of the relative prices of different products

when a single currency is used to price all three.

 Were there advantages to the sellers of accepting the euro? Explain.

o More customers were able to make more purchases in a shorter amount of

time. An advantage for the seller is the increase in sales brought about by the
reduction in the hassles customers faced in getting the right currency.

 Transaction costs are the costs involved in making an exchange or transaction.

What were some of the transaction costs you encountered in this activity?

o Lines at stores and banks.

o Searching out someone who would exchange currency privately.

o Figuring out how much currency of one kind to trade for another.

 Are transaction costs included in the price of the product you wanted to buy?

o No, they are not.

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 Who bears the burden of the transaction costs – the buyer or the seller? Who
reaps the benefits of the transaction costs – the buyer or the seller?

o Both bear the costs and neither benefits. It may help to understand the nature
of transaction costs to note that economists refer to transaction costs as
“dead weight” costs, indicating that they confer benefit on neither the buyer
nor the seller. The customer bears the cost of the opportunities lost by
standing in line. The seller derives no benefit from the customers standing in
line. The seller would, in fact, like to reduce the transaction costs because he
is afraid they will turn consumers away from his product. Because neither
buyer nor seller benefits, transaction costs are a dead-weight on the economy.

 Are transaction costs desirable or should we try to reduce them?

o Refer back to the discussion of "dead-weight" costs. We should try to reduce

transaction costs. Because they inhibit trade, they inhibit the creation of
wealth that accompanies trade.

 Use the notion of transaction costs to explain why some people chose not to
exchange their currency for euros. (What other reasons might people have for not
exchanging their currency?)

o Some may have already had the currency accepted in the store they wanted to
shop in.

o Some may have feared or anticipated a change in the exchange rate.

 Does having a common currency eliminate transaction costs? No

 What function is served by all EU countries adopting the euro?

o The elimination of those transaction costs imposed by the necessity of

currency exchange in transactions between individuals and businesses in
different countries.

o Fluctuating exchange rates increase the risk and uncertainty involved in

doing business across national borders. A common currency removes some of
the uncertainty, thus reducing the risk.

 Why might some countries be reluctant to change to a common currency?

o Two important concerns: 1) the loss of sovereignty, a country’s power to make

its own decisions and put what it perceives to be its best interests first at all
times, and 2) concern over the initial exchange rate of that country’s currency
to euros. Membership in the EU impacts nations' decisions regarding
government spending, debt, etc.

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 Extension question #1: Why is NAFTA, the North American Free Trade
Agreement, seemingly unconcerned with reducing transaction costs by converting
to a common North American currency?

o Because the U.S. dollar largely serves that function already, being commonly
accepted in both Canada and Mexico.

 Extension question #2: Why is crude oil priced in U.S. dollars throughout the
world?

o OPEC, the Organization of Petroleum Exporting Countries, decreed that it

would only transact business in dollars. Oil is used by companies all over
the world, and transaction costs for the OPEC nations are greatly reduced by
valuing oil in terms of a single currency and making exchanges based on that
currency. (In addition, OPEC also reduces the risk of dealing with
companies situated in countries with unstable currencies by choosing the
American dollar with its history as a stable currency backed by a stable
government.)

 Extension question #3: In the simulation, which currency (pinks, blues, yellows)
was able to purchase the greatest number of euros? Which was able to purchase
the least?

 Use an on-line currency converter or exchange rates listed in the daily paper.
Which currency (pinks, blues, yellows) is currently able to purchase the greatest
number of euros? Which is able to purchase the least?

 Which currency would you rather be trading for euros? Why? What factors
would influence your answer to this question?

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Visual #1 13

To convert Yellows, Blues, and Pinks:

For 5 Yellows, For 2 Blues, For 1 Pink,

you can buy you can buy you can buy

2 1 5 1 5 2

blues pink yellows pink yellows blues

To convert your currency to Euros:

For 5 Yellows, For 2 Blues, For 1 Pink,

you can buy you can buy you can buy

3 euros 3 euros 3 euros

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Copy and cut apart as follows for a class of approximately 30 students: pinks, pink paper, 10-15 sheets;
yellows, yellow paper, 8-12 sheets; blues, blue paper 12-16 sheets; euro notes – buff paper, 8 sheets

1 1
Pink Pink

1 2
Pink Pinks

1 2
Pink Pinks

1 2
Pink Pinks

1 2
Pink Pinks

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Copy and cut apart as follows for a class of approximately 30 students: pinks, pink paper, 10-15 sheets;
yellows, yellow paper, 8-12 sheets; blues, blue paper 12-16 sheets; euro notes – buff paper, 8 sheets

1 2
Blue Blues

2 2
Blues Blues

1 2
Blue Blues

1 2
Blue Blues

1 2
Blue Blues

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Copy and cut apart as follows for a class of approximately 30 students: pinks, pink paper, 10-15 sheets;
yellows, yellow paper, 8-12 sheets; blues, blue paper 12-16 sheets; euro notes – buff paper, 8 sheets

2 1
Yellows Yellow

5 2
Yellows Yellows

5 5
Yellows Yellows

5 5
Yellows Yellows

5 10
Yellows Yellows

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Copy and cut apart as follows for a class of approximately 30 students: pinks, pink paper, 10-15 sheets;
yellows, yellow paper, 8-12 sheets; blues, blue paper 12-16 sheets; euro notes – buff paper, 8 sheets

3 3
Euros Euros

3 3
Euros Euros

3 3
Euros Euros

3 3
Euros Euros

3 3
Euros Euros

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