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International Trade and Inflation

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Consider a scenario where you are an entrepreneur planning to expand your production of kitchen gadgets. You need to pay back a loan of $5,000,000 over five years. The interest rate is 5% and your other operational costs are $10,000,000 per annum. The first year after the investment your sale is 95,000 boxes of kitchen gadgets and your revenue is $9,500,000. Assuming that your sales volume remains unchanged, prepare a report on the following:

* The rate of annual inflation that will assure that you break even and will be able to pay off your loan on time.

* Assume that you now earn $142 for each box of kitchen gadgets. In addition assume that the economy has entered a period of deflation. What is the rate of deflation at which falling prices will make the venture unprofitable?

* Your kitchen gadget firm also caters to the export market. Some of the markets you export to experience inflation while others do not. List at least two advantages of exporting to countries going

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What is the rate of deflation at which falling prices will make the venture unprofitable?

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The International Financial Environment

Mesa Company specializes in the production of small fancy picture frames, which are exported from the U.S. to the United Kingdom. Mesa invoices the exports in pounds and converts the pounds to dollars when they are received. The British demand for these frames is positively related to economic conditions in the United Kingdom. Assume that British inflation and interest rates are similar to the rates in the U.S. Mesa believes that the U.S. balance-of-trade deficit from trade between the U.S. and the United Kingdom will adjust to changing prices between the two countries, while capital flows will adjust to interest rate differentials. Mesa believes that the value of the pound is very sensitive to changing international capital flows, and is moderately sensitive to international trade flows. Mesa is considering the following information:

*The U.K. inflation rate is expected to decline, while U.S. inflation rate is expected to rise.
*British interest rates are expected to decline, while U.S. interest rates are expected to increase.

1. Explain how the international trade flows should initially adjust in response to the changes in inflation (holding exchange rates constant). Explain how the international capital flows should adjust in response to the changes in interest rates (holding exchange rates constant).
3. Mesa believes international capital flows shift in response to changing interest rate differentials. Is there any reason why the changing interest rate differentials in this example will not necessarily cause international capital flows to change significantly? Explain

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