Briefly explain why the law of one price does not hold closely for most products that are traded internationally.
What will be an ideal response?
POSSIBLE RESPONSE: The law of one price holds that the price of identical goods sold in different locations must sell for the same price when prices are expressed in a common currency. The law of one price proposes that the price (P) of the product measured in domestic currency will be equated to the price (Pf) of the product measured in the foreign currency through the current spot exchange rate (e, Domestic currency/Foreign currency):
P = e • Pf
The law of one price works well for heavily traded commodities, such as gold, crude oil, and agricultural commodities, as long as governments permit free trade in the commodity. However, the law of one price does not hold closely for many products that are traded internationally such as manufactured goods. The law of one price assumes zero transaction and transportation costs, free trade, and perfect competition. In reality, transaction and transportation costs are not insignificant, and governments often create barriers to free trade. In addition, many markets are imperfectly competitive, and firms have the power to use price discrimination (charging different prices in different markets to increase profits).
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Cartel agreements are difficult to sustain because:
A. cartel members do not face the economic incentives inherent in a prisoner's dilemma. B. it's a dominant strategy for each cartel member to cheat on the cartel agreement. C. the collective payoff to all the cartel members is lower when they all abide by the cartel agreement. D. it's usually easy to discover if one of the members has cheated.
How serious is the national debt to our economic stability?
A currency appreciation is disinflationary and contractionary if the
a. inward shift of the aggregate demand curve due to the fall in exports exceeds the outward shift of the aggregate supply curve due to lower input prices. b. outward shift of the aggregate demand curve due to the rise in exports exceeds the outward shift of the aggregate supply curve due to lower input prices. c. outward shift of the aggregate demand curve due to the fall in exports exceeds the inward shift of the aggregate supply curve due to higher input prices. d. inward shift of the aggregate demand curve due to lower input prices exceeds the outward shift of the aggregate supply curve due to the rise in exports.
When does the degree of international capital mobility affect the qualitative change in the exchange rate (assume flexible exchange rates)?
a. The degree of international capital mobility is important when analyzing changes in monetary policy. b. The degree of international capital mobility is important when analyzing changes in fiscal policy. c. The degree of international capital mobility never affects the qualitative change in the exchange rate. d. The degree of international capital mobility affects the qualitative change in the exchange rate when analyzing changes in the monetary policy as well as changes in the fiscal policy.