Answer
a) You would buy American rice and sell it in Japan. Buying at the equivalent of 8,000 yen per bushel and selling at 16,000 yen per bushel would result in a profit of 8,000 yen per bushel. Eventually, the demand for American rice would increase, increasing the price of rice in America. The supply of rice in Japan would increase, decreasing the price. Eventually, the price of rice in the two countries would be the same.
b) The real exchange rate would start low. However, as Americans bought more rice and sold the rice in Japan, the exchange rate would eventually converge to 1 in the long run.
Work Step by Step
a)
American rice is 100 dollars per bushel
Japanese rice is 16,000 yen per bushel
Exchange rate is 80 yen per 1 US dollar
1 dollar = 80 yen
1*100 dollar = 80*100 yen
100 dollars = 8,000 yen
American rice is 100 dollars per bushel
American rice is 8,000 yen per bushel
$16000-8000=8000$
