The United States and Mexico can each produce automobiles for $20,000 and 230,000 pesos (P), respectively. Based on the information provided, will the United States be able to export automobiles to Mexico if the exchange rate is P10 = $US1, and trade costs are 10%?

Question

Quizplus · Accepted Answer

To compare the costs of production, we convert the cost of production of Mexico into dollars. Using the exchange rate and the cost of production of Mexico, we find that the cost of production for Mexico is $23,000 (P230,000 / 10 = $23,000).
Now, with trade costs of 10%, the cost of producing an automobile in the United States becomes $22,000 ($20,000 + 10% of $20,000). 
Comparing the costs, the United States has a price advantage of $1,000 ($22,000 - $23,000). As this price advantage more than offsets the trade costs, the United States will be able to export automobiles to Mexico.

The United States and Mexico Can Each Produce Automobiles for $20,000