Question

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) Product prices in the U.S. and Brazil have changed. Using the prices in domestic currencies

for the two countries, does the ratio of 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.

(b) 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.)

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

(d) 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.)

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

(f) Does the nominal exchange rate move toward or away from the initial ratio for,

?

Answer 1

a)if product prices in us and brazil changes the exchange rate would change depending on the direction of price change. as the price of basket of goods is larger in brazil than in us if the prices increase in brazill further then the nominal exchange rate would increase for brazil and vice versa. here the price ratio of two countries are 1400000/500000= 2.8$ so as we can see already the brazillian reals are weaker than dollars. so further change in price will affect the nominal exchange rate if not being neutralised.

b) if the imports of brazilian people increases then its supply of brazilizn real will increase and if the import declines then the supply of reals will decline compared to the previous period.

c) if imports increases then the supply of brazilian real will increase as compared to its demand so the reals strength will go down and vice versa.

d) if the imports of american people increase then the supply of american dollar will increase in the market and if the import decline then its supply will also decline as well.

e) if the imports increases the supply of dollar will increase as compared to its demand and that will make the us dollar weaker compared to the other currency and vice versa.

f) in this case the nominal exchange rate will move away from the initial exchange rate because of the change in currency values in the world market.