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.)

(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 (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.)

Answer 1

e) if the Product prices in the U.S. and Brazil have changed, the nominal exchange rate would move in either directions. if the price of basket of goods increases in brazil than in us the exchange rate for brazil will increase that means the value of brazillian real has gone down and vice versa.

f) if the imports of brazillian firms increases then the supply of brazilian real will increase in the foreign exchange market and if the imports of brazillian firms decline then the supply of brazilian real will decrease in the foreign exchange market.

g) the strength of the brazillian real will increase if the supply of it declines in the market and its demand is more. in other words if the import of firms decline and export increases the demand for brazillian real will increase and its price also increases and vice versa.

h)if there is a change in the imports of american firms the dollar will appriciate or depriciate depending on the size of import. if import increases the supply of dollar in the international market will increase then its demand which will make american dollar weaker and vice versa.