1.2.4 Great Britain and the United States produce cheddar cheese and blue cheese. Current domestic prices per pound for each type of cheese are given in the following table:

Suppose the exchange rate is £1 = $1.

a. If the price ratios within each country reflect resource use, which country has a comparative advantage in the production of cheddar cheese? blue cheese?

b. Assume that there are no other trading partners and that the only motive for holding foreign currency is to buy foreign goods. Will the current exchange rate lead to trade flows in both directions between the two countries?
Explain.

c. What adjustments might you expect in the exchange rate?
Be specific.

d. What would you predict about trade flows between Great Britain and the United States after the exchange rate has adjusted?

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Cheddar cheese Blue cheese Great Britain 3 6 United States $6 $9