Answer to Question #111599 in Macroeconomics for AA

Question

Assume that American rice sells for $100 per bushel, Japanese rice sells for 16,000 yen per bushel, and the nominal exchange rate is 80 yen per dollar.

(a) If other people exploit the same opportunity, what would happen to the price of rice in America and price of rice in Japan.

(b) Suppose rice is the only commodity in this world and law of one price and Purchasing Power Parity (PPP) theory hold. What would happen to real exchange rate between America and Japan?

Answer 1

a) as we see, the price of rice in America is lower that the price of rice in Japan($100 and $200 respectively). That means that people of both states would like to buy rice from USA, because it's cheaper. Bigger demand for US rice will cause rise in price of rice in US, and decrease in price of rice in Japan.

b) If PPP holds and rice costs $100 and 16,000 yens we can calculate the exchange rate, which will be $1=160 yens. So the exchange rate will rise.