You are a purchasing manager for General Electric and need to decide whether you should buy stainless steel from a supplier in China or source it from a foundry in Pittsburgh. If you buy it from the Pittsburgh foundry, you’ll pay $3,000 per metric ton. If you buy from China, you’ll pay 14,000 yuan per metric ton. Both prices include transportation costs. The nominal exchange rate is US$1 for 7 yuan.

a. Calculate the real exchange rate—the price of domestic steel in dollars, relative to the price of imported steel converted into dollars—and use this to decide whether you should buy the domestic or imported steel.

b. A rise in the cost of Chinese labor leads to a rise in the price of Chinese steel to 28,000 yuan per metric ton. The nominal exchange rate is still US$1 for 7 yuan. What has happened to the real exchange rate? Does this make it more or less likely that General Electric purchases steel from the foundry in Pittsburgh?