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ECO230Y1 Final: Ultimate ECO230 Exam Study Guide

Course Code
Masoud Anjomshoa
Study Guide

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Ultimate ECO230 Exam Study Guide
Part 1 - Definitions and Concepts
1. Real Exchange Rate vs Nominal Exchange Rate
The nominal exchange rate os the price of foreign currency in terms of domestic currency,
while real exchange rate is the price of foreign goods in terms of domestic goods.
2. Real Appreciation vs Nominal Appreciation
Nominal appreciation - when the domestic currency gains value relative to the foreign
Real Appreciation - when domestic goods become more expensive relative to the foreign
3. Real Depreciation
Real Depreciation - when domestic goods become cheaper relative to the foreign goods.
4. Current Account vs Financial Account
The current account keeps track of transactions on foreign and domestic goods and services,
while the financial account keeps track of transactions on foreign and domestic assets.
5. Covered vs Uncovered Interest Parity Condition
The parity between rate of return on domestic and foreign assets may be defined based on
expected exchange rate (uncovered), or forward exchange rate (covered). While the former is
risky (because expected exchange rate may turn out to be untrue), there is no risk involved in
the latter, as forward rate is enforceable, anyway.
6. Spot Exchange vs Forward Exchange Rate
Spot exchange rate is the exchange rate for trades that call for payment within a few days
from the date of transaction, while forward exchange rate is the rate that is agreed upon today
to buy or sell foreign currencies in a given date in future.
7. Long vs Short Contracts in Forward Exchange Market
In forward exchange market a promise to buy foreign exchange in future is called a long
contract, while promise to sell is called a short contract.
8. The Law of One Price vs Purchasing Power Parity Theory
The LOOP - an identical product must sell at the same price in different countries when
prices are expressed in terms of the same currency, given no transportation costs, and no
trade or legal barriers. PPP is the application of LOOP across the countries for reference
basket of goods and services, that should have the same value everywhere, expressed in the

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same currency.
9. Absolute PPP vs Relative PPP
Absolute PPP relates levels of domestic and foreign prices and exchange rate, while relative
PPP is in terms of growth rates of these variables, i.e. domestic and foreign inflation rates and
depreciation rate.
10. Undervalued vs Overvalued Exchange Rate + Balassa Samuelson Effect
Based on Balassa Samuelson Effect:
In developing countries the prices of non-tradable goods (e.g. haircut) tend to be relatively
lower than in developed countries. Non-tradable goods also constitute a big share of
consumption bundles.
The general price level tends to be relatively lower in the developing countries than in
developed countries, for the same product.
So, based on PPP, the PPP exchange rate of developing countries tends to be lower than spot
rate -> undervalued. The PPP exchange rate of developed countries tends to be greater than
spot rate -> overvalued.
11. Short Run vs Long Run
Short-run is the period of time when price are sticky (fixed), and output can be above or
below full employment level, while in the long-run output is fixed at full employment level
(given fixed inputs and technology), and price is completely flexible such that the demand
equals full employment output.
12. Open Market Operation vs Official Reserve Transaction
Official reserves transactions - when Central Banks buy/sell foreign reserves (foreign
currency, gold, foreign bonds, etc.), while with open market operations, Central Banks
buy/sell domestic assets.
13. Marshall-Lerner Condition
All else equal, a real depreciation improves the current account if export and import volumes
are sufficiently elastic with respect to the real exchange rate.
14. GDP vs GNP
GDP - the total value of goods produced and services provided in a country during one year,
while GNP is GDP plus the net income from foreign investments.
15. Exchange Rate Overshoot
The exchange rate is said to overshoot when its immediate response is greater than long-run

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16. Stolper-Samuelson Theorem
If a labor intensive good becomes more expensive, the real wage rises and real rental rate
falls, so workers are better off and capital owners are worse off. And if capital intensive good
becomes more expensive, the real wage falls and real rental rate increases, so workers are
worse off and capital owners are better off.
Part 2 - Ricardian Model (Comparative Advantage and Trade) - Example
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