The United States and Mexico can each produce automobiles for $20,000 and 230,000 pesos (P), respectively. Suppose that Mexican auto producers decide to lower their price to begin selling in the U.S. market. Given trade costs of 10%, what is the maximum price they can establish (net of trade costs) that will allow them to sell Mexican autos at the same price as U.S. autos?

Question

Quizplus · Accepted Answer

To sell Mexican automobiles in the US market at the same price as US automobiles, Mexican producers need to lower their price by the amount of trade cost (10%) which is:

230,000 x 0.1 = 23,000 pesos

So, the effective price of Mexican cars in US dollars becomes:

(230,000 - 23,000) / exchange rate

Assuming the exchange rate is 1 peso = 0.05 dollars, we get:

(230,000 - 23,000) / 0.05 = 3,940,000 dollars

This should be equal to the cost of producing US automobiles which is $20,000. Therefore, the maximum price Mexican producers can establish (net of trade costs) is:

3,940,000 / 1.1 = 3,581,818.18 pesos

This is equivalent to:

$179,090.91

However, the question asks us to give the price in pesos, so we convert this amount back to pesos by multiplying by the exchange rate:

179,090.91 / 0.05 = 3,581,818.18 pesos

Therefore, the maximum price Mexican producers can establish (net of trade costs) is P181,818. The answer is option D.

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