Analytical Problems for each of the given questions:
Question 1: A U.S. resident can earn 6% interest on a one-year bank deposit of $100,000 at home. Alternatively, she can transform the $100,000 into German marks and earn 4% on a one-year bank deposit in Germany. The initial exchange rate is 1.5 DM/US$.
a. Assume that she wishes to withdraw her money at the end of the year. If the exchange rate changes to 1.45DM/US$ at the end of the year, which deposit will give the U.S. resident a higher return? By how much (measured in U.S. dollars)?
b. At the end of the year, our U.S. investor wishes to travel to Ireland to visit the relatives. She sees that the IR£/US$ exchange rate is 0.91IR£/1$ and the IR£/DM exchange rate is 0.40IR£/1DM and the DM/$ conversion is 1.45DM/US$. Should she convert the $10,000 she wishes to take to Ireland directly from US$ to IR£, or should she first convert to DM and then to IR£? How much does (in US$) she make/lose by converting to DM first?
Question 2: Japan can make cars for $12,000 each; the US can make them for $16,000, and Mexico can make them for a cost of $20,000 each. In the questions below you are asked about the effects on the Mexican economy of a free trade agreement with the United States. Suppose that Mexican consumers will buy 1 million cars per year if the price is $20,000 and that every $1,000 drop in the price produces an additional purchase of 100,000 cars.
a. Before the free trade agreement, Mexico had a tariff on cars equal to $10,00 per car. What was the price of cars in Mexico before the FTA?
b. Mexico signs the FTA with the United States however retains the tariff of $10,000 on Japanese cars. What will the price of cars be in Mexico now?
c. What is the amount of trade diversion and trade creation caused by the FTA? Show this graphically and also numerically.
d. What is the change in Mexico’s economic welfare in going from the condition in (a) to that in (b)?