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# the limits to the exchange rate

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Question 1:
You are a manufacturing company of brooms and mops. In order to cut cost, you are thinking about shifting production of some of the products to Mexico. Additional information is provided below. (assume no quality differences, zero transportation costs, etc)

Products produced/ unit of labor
Brooms Mops
Mexico 3 OR 3
U.S. 6 OR 6

1. Assume that your company already owns facilities in the US as well as in Mexico. Would you move all production to Mexico? Is so, why? If not, would you move one product to Mexico? If so which one and why?

2. What are the opportunity costs of producing each of these goods in each country?

Additional information for question 3 and 4:
Assume that labor costs in Mexico are 100 peso per hour compared to \$9 in the US. The current exchange rate is 20 peso/ \$1.

3. Now, include the wage rates in your analysis. If you recommend moving any production to Mexico, explain your position. if you recommend not moving any production to Mexico, justify your position by determining:
i. The wage rate at which it would be optimal to move some production to Mexico
ii. The wage level at which it would be optimal to move all production to Mexico

4. What are the limits to the exchange rate at which it makes sense to produce in both countries?

##### Solution Summary

The limits to the exchange rate are discussed.

##### Solution Preview

Question 1:
You are a manufacturing company of brooms and mops. In order to cut cost, you are thinking about shifting production of some of the products to Mexico. Additional information is provided below. (assume no quality differences, zero transportation costs, etc)

Products produced/ unit of labor
Brooms Mops
Mexico 3 OR 3
U.S. 6 OR 6

1. Assume that your company already owns facilities in the US as well as in Mexico. Would you move all production to Mexico? Is so, why? If not, would you move one product to Mexico? If so which one and why?

US has absolute advantage for producing both Brooms and Mops. In US each unit of labor produces 6 Brooms or 6 Mops. Whereas in Mexico each unit of labor produces only 3 Brooms or 3 Mops. In comparative terms, both US and Mexico has the same opportunity cost of producing Brooms and Mops. In US the opportunity cost of producing 1 Broom is 1 Mop and vice ...

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