Question

1. Suppose the initial Brazilian real to US dollar exchange rate is 4 reals (or “reais”) to 1 US dollar. The cost to buy a specified market basket of same quality products is $500,000 in the U.S. and R$1,400,000 in Brazil. Valued in U.S. dollar terms, the market basket in Brazil costs $350,000. (This market basket cost represents the combined price of thousands of products, and so also indicates an average price for those products.)

(a) Consider the incentives of international sellers. Which of the following happens, an increased flow of the products into Brazil or an increased flow of products out of Brazil?

(b) What happens to general price of products in Brazil?

(c) Consider the incentives of international sellers. Which of the following happens, an increased flow of the products into the U.S. or an increased flow of products out of the U.S.?

(d) What happens to the general price of products in the U.S.?

(e) Product prices in the U.S. and Brazil have changed. Using the prices in domestic currencies for the two countries, does the ratio of ((Brazilian market basket price )/(US market basket price)) move toward or away from the initial nominal exchange rate? •

For (e and j), use the (Brazilian price/US price) ratio so as to match the (Brazilian reals/US dollar) ratio.

(f) There has been a change in the amount of imports that Brazilian firms (wholesalers, retailers etc.) buy. With this change in the buying of foreign products, what happens to the supply of Brazilian reals in foreign exchange markets? (Compared to the previous period, for example.)

(g) What happens to the price (strength, value) of the Brazilian real?

(h) There has been a change in the amount of imports that American firms (wholesalers, retailers etc.) buy. With this change in the buying of foreign products, what happens to the supply of American dollars in foreign exchange markets? (Compared to the previous period, for example.)

(i) What happens to the price (strength, value) of the US dollar?

(j) Does the nominal exchange rate move toward or away from the initial ratio for, ((Brazilian market basket price )/(US market basket price))?

2. Suppose PPP holds. Initially 85 yen (¥) buys the same in Japan as 1 Canadian dollar (C$) buys in Canada.

(a) What is the nominal exchange rate between the ¥ and the C$?

(b) There is then 3% inflation in Japan and 11% inflation in Canada. (This could occur over the course of just one year or over the course of multiple years, it doesn’t matter.) What is the nominal exchange rate after this inflation? Give the exchange rate to one decimal and in per C$1 terms.

(c) Did the Japanese yen appreciate or depreciate (in a nominal sense) over this period?

3. Suppose the real exchange rate rises (perhaps from a neutral level) for the domestic currency of a country.

(a) Are domestic consumers helped or hurt?

(b) Is the domestic tourist industry helped or hurt?

(c) Are domestic investors (who buy international securities) helped or hurt?

4. Suppose the real exchange rate falls (perhaps from a neutral level) for the domestic currency of a country.

(a) Are domestic residents traveling abroad helped or hurt?

(b) Are domestic businesses that use foreign parts helped or hurt? (We’ll say these businesses don’t face foreign competition for their products.)

(c) Are domestic producers that face foreign competition helped or hurt? (We’ll say these producers don’t import parts.)

(d) What happens to domestic inflation?

Answer 1

Answer 1:

a.Since the selling cost in Brazil is lower than the selling cost in the United States, thus international sellers will make losses by selling their product in Brazil, thus , there will be increased flow of products out of Brazil.

b. The flow of products out of Brazil will lead to fall in the overall quantity supplied in Brazil and thus there will be increase in the price level in Brazil.

c. Since the selling cost in the United States is higher, thus there will be increased inflow of products in the United States by international sellers as they can make more profits by selling in the United States.

d. The level of the quantity supplied in the United States rises and thus price level in the United States will fall due to rightward shift of the supply curve in the United States.