Chapter 4 Purchasing Power Parity and Exchange Rate International Economics

For which of the following will the law of one price hold best?

 a. gold

 b. butter

 c. shirt

 d. milk

 e. newspaper

a. gold

Assume that the domestic price level is 2 and the foreign price level is 1. What is the PPP exchange rate?

 a. 2

 b. 1

 c. 1/2

 d. Not enough information is given.

a. 2

Relative PPP indicates that

 a. the exchange rate between any two currencies is equal to the ratio of their price indexes.

 b. the same good sells for the same price internationally.

 c. the percentage change in the exchange rate is equal to the inflation differential between the domestic and foreign country.

 d. relative prices determine exchange rates.

c. the percentage change in the exchange rate is equal to the inflation differential between the domestic and foreign country

We can expect deviations from PPP because of

 a. quotas

 b. tariffs

 c. transportation costs

 d. differentiated goods

 e. all of the above

e. all of the above

PPP holds better for ________ countries.

 a. low-inflation

 b. poor

 c. rich

 d. high-inflation

 e. middle-income

d. high-inflation

Which of the following is incorrect?

 a. Exchange rates in the short run are much more variable than inflation differentials.

 b. Deviations from PPP are much more apparent for monthly data than annual.

 c. PPP holds best in the long run.

 d. An assumption of MAER is that PPP holds.

 e. none of the above

e. none of the above

If absolute PPP holds, then relative PPP will also hold.

 a. True

 b. False

a. true

Suppose the nominal exchange rate is 2, the domestic price level is 4, and the foreign price level is 1. What is the real exchange rate equal to?

 a. 0.75

 b. 0.5

 c. 4

 d. 2

 e. 8

b. 0.5

If the exchange rate is equal to the ratio of the domestic and foreign price indexes

 a. absolute PPP holds

 b. relative PPP holds

 c. one currency is overvalued

 d. one currency is undervalued

 e. none of the above

a. absolute PPP holds

If absolute PPP holds, then the real exchange rate must be equal to

 a. a constant

 b. one

 c. zero

 d. a positive number

 e. a negative number

b. one

Suppose the average price of a Big Mac in the United States is $3.50 while in Japan the average price is 400 yen. If the market exchange rate is that 1 dollar is exchanged for 100 yen, the purchasing power parity model of exchange rate determination suggests that:

 a. the yen is overvalued

 b. the yen value is correct

 c. the price of Big Mac in Japan will rise

 d. the dollar will depreciate against the yen

a. the yen is overvalued

PPP is empirically confirmed theory of exchange rate determination

 a. True

 b. False

b. False

The empirical data indicate that in the short run exchange rates are much more variable than inflation differentials.

 a. True

 b. False

a. True

The law of one price applies to non-traded goods because of arbitrage.

 a. True

 b. False

b. False

Developing countries' currencies often tend to be undervalued because of lower labor productivity.

 a. True

 b. False

b. False