Economics 2152A/B Study Guide - Final Guide: Foreign Exchange Market, Pearson Education, Real Wages

When a country's real exchange rate appreciates:

a. Its nominal exchange must have also appreciated.

b. Foreign goods become more expensive in terms of domestic purchasing power.

c. It could result if the domestic exchange rate is pegged in terms of the foreign exchange rate and foreign inflation rates are relatively high compared to domestic inflation rates.

d. It could result if the domestic exchange rate is pegged in terms of the foreign exchange rate and domestic inflation rates are relatively high compared to foreign inflation rates.

1.Purchasing power parity implies that

a. the real exchange rate is equal to 1.

b. the law of one price does not hold.

c. inflation rates are equal across countries.

d. the real exchange rate is equal to 0.

e. if the domestic country has low prices, then the domestic currency will depreciate until foreign citizens can buy the same amount of goods as domestic citizens.

2.Which of the following is a prediction from the PPP model of exchange rates?

A. An increase in the US money supply leads to an appreciation of the dollar in the long run.

B. An increase in US production leads to a depreciation of the dollar.

C. An increase in US production will lead to a proportional increase in the inflation rate.

D, An increase in the US money supply leads to a depreciation of the dollar in the long run.

E.An increase in the US interest rates leads to a fall in prices.

3.Relative purchasing power parity predicts that

A.the difference between the inflation rates in the two countries should equal the ratio of the interest rates in the two countries.

B. the difference between the inflation rates in two countries should equal the per cent change in the exchange rate.

C.inflation rates should be equal across countries.

D.the real exchange rate should equal one.

E.relative price levels in the two countries should be equal when expressed in the same currency.

4.Which of the following is NOT a valid explanation for the failure of purchasing power parity?

a. Differences in monetary policies across countries

b. Lack of competition

c. Transportation costs

d. Trade barriers

5.If P represents (the level of) domestic prices, P* represents (the level of) foreign prices and E represents the exchange rate as units of domestic currency per units of foreign currency, then the real exchange rate equals

6.The difference between nominal and real interest rates is that

A.Nominal interest rates are measured in terms of a country's output, while real interest rates are measured in monetary terms

B.Nominal interest rates are measured in monetary terms, while real interest rates are measured in terms of a country's output

C.Nominal interest rates can fluctuate, while real interest rates always remain fixed

D.Real interest rates can fluctuate, while nominal interest rates always remain fixed

E.Real interest rates are the same in every country, while nominal interest rates are different for every country

7.Which of the following is predicted to cause the value (or price or cost) of U.S. goods to appreciate relative to the value (or price or cost) of foreign goods in the long run?

a. An increase in the growth rate of U.S. GNP. b. A decrease in the growth rate of U.S. GNP.

c. A decline in the growth rate of the U.S. money supply.

d. An increase in the price of petroleum that reduces world demand for American cars. e. An appreciation of the dollar.

In the long run, exchange rates reflect purchasing power parity (PPP). This theory called the law of one price, aggregates and generalizes the idea that the same good must sell for the same price, in the same currency units, regardless of where it is produced. The following questions consider how PPP and the law of one price work and whether they can explain long-run exchange rate movements.

PPP may not hold because:

A. The law of one price applies, on average, to all goods.

B. Countries are gradually reducing trade restrictions.

C. All goods and services can trade at a relatively low cost.

D. Goods produced in different countries vary greatly in quality.