Final answer:
A nearby dollar is worth more than a distant dollar because the present value of money is higher due to its earning potential. Factors like higher rate of return and inflation can affect the desirability and strength of a currency, influencing exchange rates and perceived value.
Step-by-step explanation:
The perception that a nearby dollar is worth more than a distant dollar is based on the concepts of time value of money and opportunity cost. In finance, money available at the present time is considered to be worth more than the same amount in the future due to its potential earning capacity. This core principle suggests that a dollar today is worth more than a dollar tomorrow. When assessing the value of a currency, like the U.S. dollar, several factors come into play, including inflation rates and foreign exchange dynamics.
For example, if the U.S. experiences a higher rate of return for its dollars, this raises their desirability, shifting demand in the foreign exchange market and potentially increasing the strength of the dollar compared to other currencies. Conversely, relative inflation can erode the purchasing power of a currency. If a country like Mexico faces high inflation, as in the 1986-87 example, the value of the peso decreases internationally, leading to less demand and an increased supply, ultimately weakening its exchange rate value.
Behavioral economists argue that people often think of financial outcomes relative to a reference point and as percentages, not just absolute amounts. This mentality can influence how we perceive the value of money based on when and where it is available. Additionally, for foreign tourists, a weaker dollar may be beneficial as it allows their own currency to stretch further, making travel to the U.S. more affordable, thereby potentially increasing tourism.