Check Your Understanding

1. Question

   Suppose Mexico discovers huge reserves of oil and starts exporting oil to the United States. Describe how this would affect the following:

   1. the nominal peso–U.S. dollar exchange rate

   2. Mexican exports of other goods and services

   3. Mexican imports of goods and services

2. Question

   Suppose a basket of goods and services that costs $100 in the United States costs 800 pesos in Mexico and the current nominal exchange rate is 10 pesos per U.S. dollar. Over the next five years, the cost of that market basket rises to $120 in the United States and to 1,200 pesos in Mexico, although the nominal exchange rate remains at 10 pesos per U.S. dollar. Calculate the following:

   1. the real exchange rate now and five years from now, if today’s price index in both countries is 100. [Reminder: Equation 15-1 provides the price index formula: (Cost of market basket in a given year/Cost of market basket in base year) × 100. For this problem, use the current year as the base year.]

   2. purchasing power parity today and five years from now