ECON10003 Lecture Notes - Lecture 21: Big Mac Index, The Foreign Exchange, Real Interest Rate

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.

Assume that the U.S. dollar and the Japanese yen are the only two currencies in the world.

a. A bilateral nominal exchange rate S is the spot (now) exchange value of one currency in terms of the other and S can be written as dollars per 1 yen or yen per 1 dollar. If S = yen/1 dollar = 76.92 then the inverse 1/S gives dollars per 1 yen where 1/S = 1/(yen/1 dollar) = 1/76.92 = .013. If the 1/S increases to .014, has the dollar appreciated (1 dollar is worth more yen) or depreciated (1 dollar is worth less yen)? Explain.

b. Changes in demand and supply in the foreign exchange (FX) market determine the value of floating exchange rates S. If S is expressed as S = yen/1 dollar, then we have the FX market in terms of the demand and supply of dollars. (If S = dollars/1 yen, then we get the FX market in terms of the demand and supply of yen. Note also that no matter which currency the FX market is expressed, it is still an FX market where dollars are exchanged for yen. This means that an upward-sloping supply of dollars curve is exactly the same as a demand for yen curve and a downward-sloping demand for dollars curve is exactly the same as a supply of yen curve). Using S = yen/1 dollar and the FX market in terms of the demand and supply of dollars, an increase in S (dollar appreciation) leads to an increase in the number of dollars supplied (increase in the quantity of yen demanded). For dollar demand (or the supply of yen), an increase in S (dollar appreciation) leads to a decrease in the number of dollars demanded (or an increase in the number of yen supplied). The dollar demand curve shifts to the right if more yen are offered for dollars at any exchange rate S. An increase in dollar demand is caused mostly by private sector transactions in the current and capital accounts. Either an increase in demand for U.S. goods (merchandise trade in the current account) or an increase in demand for U.S. stocks and bonds (capital account inflows) will shift the dollar demand curve to the right. If private transactions in the current and capital accounts also cause shifts in the dollar supply curve, what are the corresponding factors that would lead to an increase in dollars supplied (yen demanded) at any exchange rate S?

2.) In a simple economy (assume there are no taxes; thus, Y is disposable income), the consumption is C=50+0.80 Y. The current level of real GDP is $3000.

At this level of real GDP, consumption will be $___, and savings will be $___. If GDP were to increase by $1000, consumption would increase by $___. (Round off response to nearest dollar.)

At a real GDP level of $3000, the average propensity to conumer is $___, and the average propensity to save is ___. (Round off response to nearest dollar.)

11.) In the short run, if the economy has a recessionary gap, an increased government deficit resulting from higher government spending or lower taxes is most likely to :

a) increase aggregate demand, which will move the economy toward full employment real GDP

b) have no effect on aggregate demand or real GDP after direct and indirect offsets are counted

c) increase aggregate demand, raising prices and creatring an inflationary gap

d) decrease aggregate demand, reducing prices and increasin the recessionary gap

14.) The Federal reserve purchases $9 million in uS Treasury bonds from a bond dealer, and the dealer's bank credits the dealer's account. The required reserve ratio is 17 percent , and the bank typically lends any excess reserves immediately. Assuming that no currency leakage occurs, calculate how much much will the bank be able to lend to its customers following the fed's purchase. $ __ million. (round off to 2 decimal points)

18.) According to the quantity theory of money, the prices, a -3% change in the money supply, holding other variables constant leads to a

a) -3% changee in real GDP

b) -3% change in the interest rate

c) -3% change in the price level

d) a greater than -3% in real GDP

24. Over the course of a year, a nation tracked its foreign transactions and arrived at the following amounts:

Merchandise exports 500

service exports 75

net unilateral transfers 10

domestic assets abraod (capital outflows) -200

foreign assets at home (Capital inflows) 300

changes in official reserves -35

merchandise imports 600

service imports 50

This nations' blance of trade is ______

Its current account balance is ______

The nation's capital account balance is _____

27. Major discoveries of the highest-quality dia-monds ever found occur in Russia andCentralAsia, causing a significant decline in purchases ofSouth African diamonds. Moreover, assume a floating exchange rate.

Describe how the market for the rand is impacted by this event. Will demand shift to the left? Will supply remain the same? Or will supply change?