International Econ 201

Day 1,247, 06:14 • Published in Romania Canada • by lucifer_ultionis

In the previous article we saw what happens to the prices in the eWorld when there are no trade barriers, no currencies. Specifically when there are no impediments for trading between countries, price differences (in gold) create profit opportunities. When these profit opportunities are exploited, as described by the supply and demand curves in the previous article, they tend to disappear leaving the world with a single price. This is so called "The Law of One Price" because the Prices will adjust until there are no profit opportunities to be exploited on.

Today we will examine, according to our curricula 🙂, what happens if we ADD National Currencies in the Game 🙂 but we keep all other assumptions constant:
That is:
Assumptions:
1. No barriers to trade
2. No license costs
3. Suppose also for simplicity that there are only 2 Countries (Romania and Canada
4. No spreads (i will explain what it means shortly)

How do we define an exchange rate? Let's say we have the following exchange rates:
Ex(RON/Gd) = 100Roni/ 1 Gold ... that is for 100 RONs you will get 1 Gold, and for 1 Gold you'll get 100 Roni (that is calle😛 no spreads... no idea how that would be in Romanian)
and the exchange in Canada is:
Ex(cAD/GD) = 125 CADs per 1Gold


Now stop for a second and thinK: For the LAW of One Price to Work, That is: For NO PROFIT opportunities to be exploited we would need to have:
Price(Grain in Romania) / Ex(RON/GD) = Price(Grain In canada) / Ex(CAD/GD)


Suppose 1 Grain costs RON 41 in Romania and 50 CAD in Canada. Under Ex(RON/Gd) = 100, and Ex(CAD/GD)= 125 , which country will be the exporter which one will be the Importer? Not so obious this time, eh? 🙂 ? Let's do the ratios:


41/100 =0.41
50/125 = 0.4

Wow! Romania, even though in Nominal Prices the Grain is Cheaper, now has a Higher PRICE in Gold than Canada, therefore now Romania will be The IMPORTER of Grain and Canada will be the Exporter because the Price is cheaper.

now, for the law of one price to take place, we NO LONGER need the Nominal Prices to be the same between the two countries, now the exchange rate can change too(if it's not pegged by the Government, and we will see what happens If the Government Creates a Central Bank that peggs its National Currency).
All we need, for the equilibrium is:
Price(Grain in Romania) / Ex(RON/GD) = Price(Grain In canada) / Ex(CAD/GD)

If the Ex(ROn/GD) after we take gold from Romania goes UP to 102.5, it will act as a DECREASE IN REAL PRICE of the commodities. In our case GRAIN will now cost:
41/102.5=0.4 , and guess what: NO MORE PROFIT Opportunities between Canada and Romania.

The important thig is:
Exchange rates are subject to the same laws as other commodities: Demand and Supply! However the Demand and Supply for Currencies is a DERIVED DEMAND. Both in REal Life and In Erepublik we BUY Currencies for two main reasons: To buy stuff and for speculation, it is JUST a medium of Exchange and it is SUBJECT of demand and supply NOT THE OBJECT of it!

Now a question for a Prize 😁)
Suppose:
Suppose 1 Grain costs RON 40 in Romania and 50 CAD in Canada. Under Ex(RON/Gd) = 100, and Ex(CAD/GD)= 125.
1. Are there any profit opportunities for Traders?
2. Suppose There is a Trade Embargo between Romania and Canada, and new businesses of Grain open up in Canada.
2.a: What will happen to the price of Grain in Canada? (eays)
2.b: What will happen to the price of Grain in Romania? (eays)
2.c: What will happen to the exchange rate? Ex(CAD/GD) Ex(RON/GD) (medium)
Now suppose the Trade embargo is ended, Answer 2a, 2b, 2c again 🙂
Good luck!!! 🙂

To help you answer the questions, you can also read the Principles of Demand and Supply, a really GREAT Article with a Beautiful Graph that might change the way you view the world forever 🙂, written by yayoATefnet


ps
I'll GIVE YOU 1 BREAD per correct answer (you can get 7 breads if you answer all questions correctly... and if you answer all of them correctly I'll give you 3 extra! Just because! 😃 So you'll get 10 in total).

UPDATE:
desert0 got ALL QUESTIONS RIGHT = 10 breads (he doesn't want them though 🙂 ... so he's willing to give them away too...