Question 2-15 points

Consider the relative supply (RS) and relative demand (RD) for Mexican goods relative to the US goods. Using an appropriate graph, answer the following questions (you can draw a graph in your rough work, there is no need to include them in the exam). Explain which curve will shift and in which direction, and also your final result for real exchange rate (q_peso/$) and real relative (ratio of) Mexican to US. output.

a)Suppose there is an increase in preference for Mexican goods over US goods. What will happen to the real exchange rate and real relative output in Mexico? Explain. (5)

b)

Now suppose there is an increase in education levels in Mexico which increases labor productivity in Mexico. What will happen to the real exchange rate and real relative output in Mexico? (5)

c)What will happen to the real exchange rate and real relative output in Mexico if there is an increase in Mexican productivity and also an increase in preference for Mexican goods over US goods? (5)

c)What other effects are felt on the economy's BOP and its current account (immediate and gradual effects) after the revaluation? Explain. (4)