Consider coffee produced in US and Mexico. We assume that coffee produced in two
ID: 1213927 • Letter: C
Question
Consider coffee produced in US and Mexico. We assume that coffee produced in two countries are identical, and that in US, coffee sells for $10 per pound. The exchange rate E$/peso = 0.10.
a) If the law of one price holds, what is the price of coffee in Mexico measured in peso?
(b) Assume that the price of coffee is actually 90 peso per pound. Compute the relative price of coffee in Mexico versus to US. Where will the traders buy coffee? How will these transactions affect the price of coffee in US?
Explanation / Answer
a. Acc. to law of one price , price of coffee should be same in both countries
So, price of coffee in Mexico = $10
Hence, the price of coffee in Mexico measured in peso = 10/0.10 = 100 peso
b. the relative price of coffee in Mexico versus to US = price of coffee in Maxico/Price of coffe in US = 90/100 = 0.90
the traders will buy coffee in U.S as Coffee is ch.eaper in Mexico as compared to U.S
These transactions will reduce the price of coffee in US.
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