Question

A firm manufactures a product in the United States. Its costs of production and shipping are $100. It sells the product in Silliestan for 1000 Zlotys which is equivalent to $500 (2 Zlotys = $1). Costs of distribution and selling in Silliestan are $100 (200 Zlotys) so the firm has a profit of $300. Within the next year, the Zloty is expected to fall from 2 Zlotys to the dollar to 4 Zlotys to the dollar while inflation in Silliestan is expected to be 100%. US costs, in dollars, are not expected to change.

Show all calculations. No points for the correct answers without calculations.

a) Given these expected changes, how many Zlotys will it cost, in total, to make the product in the United States and to sell it in the foreign country? The total costs of manufacture, shipping and sales will be ______________________ Zlotys. 2 points

b) If you sell the product for 1000 Zlotys, how much would your profit or loss be? ________ Zlotys 2 points

c) What other factors should be taken into account when setting a price? Be specific. 1 point.

d) If your company sells the same product in a neighboring country for a higher price, this would give rise to a ____________________ market. 1 point

e) If the foreign country were to ask your firm to take partial payment in a local product, say turnips, this would be an example of ________________________ . 1 point.

Answer 1

Current exchange rate is $1 = 2 Zlotys

The product is manufactured in the United States. Per product cost of Production and Shipping (p) = $100

Selling price per product in Silliestan (s) = 1000 Zlotys (or $500)

Costs of distribution and selling in Silliestan (d) = $100 (or 200 Zlotys)

Total Cost per product (c) = p + d = $200

Profit per product = s - c = $300

Now, due to inflation, Zloty is expected to fall. New exchange rate is $1 = 4 Zlotys. There is no change in the U.S. currency. Only Zloty has depreciated.

Since the $ remains the same in value, p will remain the same.

p new = p = $100

Since Zloty has depreciated, d new = $100 (or 400 Zlotys)

Thus, new total cost (c new) = p new + d new = $200 (or 800 Zlotys)

a) Given these expected changes, how many Zlotys will it cost, in total, to make the product in the United States and to sell it in the foreign country? The total costs of manufacture, shipping and sales will be 800 Zlotys.

If selling price per product is kept at 1000 Zlotys, profit per product = 1000 Zlotys - 800 Zlotys = 200 Zlotys.

b) If you sell the product for 1000 Zlotys, how much would your profit or loss be? Profit of 200 Zlotys

c) What other factors should be taken into account when setting a price? Be specific.

The other factors that should be taken into account when setting a price other than costs and exchange rate are profit margin, demand fluctuation due to inflation and competitive pricing.

d) If your company sells the same product in a neighboring country for a higher price, this would give rise to an arbitrage market.

This is because people will buy the product in the country where the product is selling cheaper and sell it in the neighbouring country for a higher price. The market will soon come into equilibrium and the company will have to adjust its prices to keep them same in real terms.