The real exchange rate between Canada and U.S. must be unity if LOOP is found held for all the
common goods that are consumed in both countries. True or false?
False
I found the following power point on the web which explains.
(Broken Link Removed)
False. The real exchange rate between Canada and the U.S. does not have to be unity if LOOP (law of one price) holds for all common goods consumed in both countries.
The law of one price states that when markets are competitive and there are no trade barriers or transportation costs, identical goods should have the same price in different countries when measured in the same currency. In other words, the prices of goods in different countries should equalize after accounting for exchange rates.
However, even if the law of one price holds, it does not necessarily mean that the real exchange rate between two countries will be equal to one. The real exchange rate is determined by a variety of factors, including interest rates, inflation rates, trade flows, and market expectations.
In practice, real exchange rates between countries can and do deviate from unity, even for goods that are consumed in both countries. These deviations can occur due to factors such as productivity differences, differences in demand and supply conditions, and government policies, among others.
Therefore, the statement that the real exchange rate between Canada and the U.S. must be unity if LOOP holds for all common goods is false.