I don\'t really understand this at all. So can someone explain this to me in sim

Question

I don't really understand this at all. So can someone explain this to me in simple terms?

Creating a High Black Market Premium I was lounging on Negril Beach in Jamaica, recovering from the rigors of a consulting assignment in Kingston, when a local entre- preneur made me an attractive proposition. He offered to trade me Jamaican dollars for American currency at a rate 65 percent more favorable than the official exchange rate I get at the hotel. (Since a transaction was illegal under Jamaican law, I'm not going to tell you whether I accepted his offer.) But why would he make such an offer? he Jamaican government did not allow its citizens to buy Ameri- can dollars except in small amounts for tourist travel. Jamaicans would have liked to hold dollars as a hedge against devaluation of the Jamaican dollar, so there was more demand for U.S. dollars than could be satisfied through official channels at the official exchange rate. The official exchange rate did not price U.S. dollars high enough compared to the value that Jamaicans placed on them-hence, the offer of the local entrepreneur to pay a higher price for my U.S. dollars than the official rate the Jamaican banks were offering. The same phenomenon is common around the world. How does the existence of a black market premium affect the incentives for growth? First, there is obviously a strong incentive to get access to U.S. dollars at the official rate and resell them at the black market rate. This creates fierce competition for licenses to buy U.S. dollars. Anytime the main profit opportunity in the economy is to get around government rules, not much good is going to happen in the real economy.

Explanation / Answer

Hi

I think you need the basic concept being discussed here.

In these paragraphs, the Black Market Premium has been discussed. A premium basically refers to the excess amount paid to procure something.

In various countries llike Jamaica, there is a restriction on the amount of American dollars that can be purchased by the citizens. However, many citizens desire to purchase them in large quantities due to 2 reasons:

1. They prefer to hold American Dollars as a form of secured investment.

2. They sell the American Dollars to other citizens in the black market, i.e, at abnormally high prices illegally.

On the other hand, in the official foreign exchange market, the demand for American Dollars stays low due to the governmental restrictions. The low demand ensures that the price of American Dollars does not get too high.

Now, we have got 2 observations, Citizens prefer to purchase more American Dolalrs so they are willing to pay a high price for them while in the official market, they cannot demand more thus the price is less.

Thus, the actual black market price on which American Dollars are traded is higher than the official price of American Dollars.

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