Assume that the only good traded between Mexico, the U.S., and Canada is chicken, which is produced by all three countries. If the cost of producing a pound of chicken is 5 pesos in Mexico, 1 U.S. dollar in the U.S., and 2 Canadian dollars in Canada, and if the law of one price holds, what are each of the exchange rates between the three countries?
What will be an ideal response?
Because chicken is the only traded good and the law of one price holds, then 5 pesos = 1 U.S. dollar = 2 Canadian dollars, so the exchange rates are 5 pesos per U.S. dollar or 0.2 U.S. dollars per peso; 2 Canadian dollars per U.S. dollar or 0.50 U.S. dollars per Canadian dollar; and 2.5 pesos per Canadian dollar or 0.4 Canadian dollars per peso.
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