The price of a loaf of bread is
$1 in the United States, whereas it is 2 pounds in England. The prevailing
exchange rate between the dollar and the pound is $1 for 1 pounds. Is this a
sustainable exchange rate? If not, describe the changes that will bring the
exchange rate to equilibrium.
Since $1 = 1 pound, price of goods must be same in US and England.
As given loaf of bread is $ 1 in US and 2 pounds in UK which is NOT sustainable.
People will buy loaf of bread from US and sell in UK. Seeing this kind of easy profit, more and more people will do this business. Over a period of time, supply of bread in US for domestic consumption will decrease and its price will increase. This price will increase till the price of bread in both the countries become same (i.e. $2).
Let me know if you need further help.
May 4th, 2015
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