Assume that American rice sells for $100 per bushel, Japanese rice sells for 16,
ID: 1181595 • Letter: A
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) Explain how you could make a profit from this situation. What would be your profit per bushel of rice? If other people exploit the same opportunity, what would happen to the price of rice in Japan and the price of rice of rice in the United States
(b) Suppose that rice is the only commodity in the world. What would happen to the real exchange rate between the United States and Japan?
Explanation / Answer
a. To make a profit, you would want to buy rice where it is cheap and sell it where it is expensive. Because American rice costs 100 dollars per bushel, and the exchange rate is 80 yen per dollar, American rice costs 100 x 80 equals 8,000 yen per bushel. So American rice at 8,000 yen per bushel is cheaper than Japanese rice at 16,000 yen per bushel. So you could take 8,000 yen, exchange them for 100 dollars, buy a bushel of American rice, then sell it in Japan for 16,000 yen, making a profit of 8,000 yen. As people did this, the demand for American rice would rise, increasing the price in America, and the supply of Japanese rice would rise, reducing the price in Japan. The process would continue until the prices in the two countries were the same. b. If rice were the only commodity in the world, the real exchange rate between the United States and Japan would start out too low, then rise as people bought rice in America and sold it in Japan, until the real exchange became one in long-run equilibrium.Related Questions
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