1. If there is 10% inflation in Brazil, 15% inflation in Argentina, and the Argentine peso weakens by 21% relative to the Brazilian real, by how much has the peso strengthened or weakened in real terms? What effect do you expect that this change in the real exchange rate would have on trade between the two countries?
2. Suppose that you have one domestic production facility that supplies both the domestic and foreign markets. Assume that the demand for your product in the domestic market is Q = 2,000 - 3P, and in the foreign market, demand is given by Q* = 2,000 - 2P*. Assume that your domestic marginal cost of production is 600. If the initial real exchange rate is 1, what are your optimal prices and quantities sold in the two markets? By how much will you change the relative prices of your product if the foreign currency appreciates in real terms by 10%? What will you do to production?