Question

Consider the exchange rate between the US dollar and the Canadian dollar. Suppose today we observe an exchange rate of E_US$/C$ = 0.80. Moreover, suppose that you can buy a backpack in Canada for C$140 and in the US for US$90. For each of the exchange rates below, determine if there is an appreciation or depreciation of the U.S. dollar relative to the Canadian dollar and if you would rather buy the backpack in the U.S. or in Canada.

1. If the exchange rate is E_US$/C$ = 0.87, the price of a Canadian backpack in US dollars is:

2. If the exchange rate is E_US$/C$ = 0.87, the relative price of a Canadian backpack is:

Answer 1

So, the current exchange rate is “E(US/C) = 0.80”, => to purchase “1 unit” of “C$” we have to pay “0.8” “US$” and the price of “backpack” in Canada is “P* = C$140” and in US is “P = US$90”.

Now, if the exchange rate is “E(US/C) = 0.87 > 0.8”, => price of “C$” has increased in terms of “US$”, => it’s a depreciation of US$, => the price of Canadian backpack in US$ is “E*C$140 = 0.87*140 = US$121.8”. Since the “US” price of Canadian backpack is expensive compared to US backpack, => one should not buy it from Canada.

So, here the relative price of a Canadian backpack is “0.87*140/90 = 1.35” is US$.