Question

2. a) Using your RS and RD diagram, illustrate the effects of the increase of the demand for US goods on the Mexican RER (Mexico is the home currency). 5 points.

(b) If Mexico currently has a balanced trade, will the scenario above cause Mexico to have a trade deficit or a trade surplus in the future? Explain. 5 points.

Answer 1

(a) The Standard Trade Model is a general model that involves Ricadian, certain factors, and Heckscher-Ohlin models as special matters.The standard trade model is stand on four main relationships: (1) the association between the production possibility frontier and the relative supply curve; (2) the correlation between relative prices and relative demand; (3) the conviction of world equilibrium by world relative supply and world relative demand.
The Standard Trade Model base on RS-RD factors.

The effects of the increase of the demand for US goods on the Mexican RER;
The value of RER Will depreciate because the United States would be selling goods to Mexico.

(b) , When the value of Mexico currency depreciates, imports become more expensive, so locals often purchase little imported goods. On the other hand, exported goods cost little to international buyers, so their demand tends to increase. Little imports and more exports will decrease the trade deficit and could lead to a surplus.