Question 1

The actual exchange rate of the real, Brazil's currency, is 2.40 real per U.S. dollar. According to the PPP estimation, the exchange rate should be 1.20 real per U.S. dollar. This implies that the real is:

Accepted Answer

The PPP (Purchasing Power Parity) estimation suggests the real should be stronger (1.20 real per U.S. dollar) than it currently is (2.40 real per U.S. dollar). This means the real is undervalued. To find the percentage, compare the actual rate to the PPP rate: (2.40 - 1.20) / 1.20 = 1.00 or 100 percent undervalued. However, since none of the options correctly reflects this calculation, the closest correct option based on the given choices is A) undervalued by 50 percent, assuming a misunderstanding in the calculation process.

Question 2

Purchasing power parity is used to estimate:

Accepted Answer

Purchasing power parity (PPP) is primarily used to estimate changes in long-run exchange rates, based on the idea that in the long run, exchange rates should adjust so that an identical good in two different countries has the same price when expressed in the same currency.

Question 3

For many years, China tightly managed its currency through intervention and capital controls, effectively pegging the yuan to the U.S. dollar (a rate of about 8 yuan per dollar). Which of the exchange rate regimes discussed in the textbook did China have at that time?

Accepted Answer

China's policy of maintaining its currency at a constant rate against the U.S. dollar is an example of a fixed exchange rate regime. In this system, the country's government or central bank sets and maintains an official exchange rate with a foreign currency or a basket of currencies.

Question 4

When a country occasionally buys or sells currencies to influence the exchange rate, but usually lets market forces determine the exchange rate, it has a:

Accepted Answer

A partially-flexible exchange rate system allows a country to intervene in the currency market to buy or sell currencies to influence the exchange rate, but generally lets market forces set the rate. This is unlike a purely flexible exchange rate, where the market determines the rate without government intervention, or a fixed exchange rate, where the government sets and maintains the rate.

Question 5

Purchasing power parity is criticized because it:

Accepted Answer

Purchasing power parity does not account for trade in assets, which can lead to deviations from the predicted exchange rate.

Question 6

If a basket of goods costs 10 dollars in the United States and 11 euros in Belgium, then purchasing power parity will exist if the exchange rate between the euro and the dollar is:

Accepted Answer

Purchasing power parity (PPP) exists when the cost of a basket of goods is the same in both countries when measured in a common currency. Here, for PPP to hold, 10 dollars must be equivalent to 11 euros, meaning 1 dollar equals 1.1 euros.

Question 7

In what type of exchange rate system is the level of official reserves the most important?

Accepted Answer

In a fixed exchange rate system, a country's central bank uses its reserves to buy and sell its own currency to maintain its exchange rate at a fixed value, making the level of official reserves crucial.

Question 8

Suppose 60,000 pesos buys a basket of goods in Mexico. If, at the existing exchange rate, it costs less than 60,000 pesos to buy the same basket of goods in the United States, then purchasing power parity implies that the:

Accepted Answer

Purchasing power parity implies that the exchange rate should adjust so that the same basket of goods costs the same amount in both countries. If it costs less than 60,000 pesos to buy the same basket of goods in the United States, then the dollar should cost more pesos to maintain purchasing power parity.

Question 9

The actual exchange rate of the real, Brazil's currency, is 2.50 real per U.S. dollar. According to the latest PPP estimations, the real is undervalued by 40 percent. This implies that the PPP exchange rate is:

Accepted Answer

If the real is undervalued by 40%, it means the actual exchange rate is 40% higher than the PPP rate. To find the PPP rate, calculate 60% of the actual rate: 2.50 * 0.60 = 1.50 real per dollar.

Question 10

Suppose a McDonald's Big Mac costs 30 pesos in Argentina. At the same time, suppose the exchange rate between the peso and the euro is roughly 15 pesos per euro. According to purchasing power parity, a Big Mac in Europe should cost:

Accepted Answer

According to purchasing power parity, the price of goods should be the same in different countries when expressed in a common currency. Given the exchange rate of 15 pesos per euro, a 30 peso Big Mac in Argentina would cost 30 / 15 = 2 euros in Europe.

Question 11

Suppose a given basket of goods and services costs 6 dollars in the United States and 4,500 won in Korea. If the exchange rate is 900 won per dollar, purchasing power parity implies that the:

Accepted Answer

Purchasing power parity implies that the exchange rate should equalize the price of the basket in both countries. At 900 won per dollar, the basket costs 5,400 won in Korea (6 dollars * 900 won/dollar), which is more than the 4,500 won it actually costs. Therefore, the dollar must depreciate to make the basket cost the same in both countries.

Question 12

Macroeconomic policy is:

Accepted Answer

Macroeconomic policy is most limited under fixed exchange rates because the government commits to maintaining the exchange rate and must adjust its monetary policies accordingly, often at the expense of other macroeconomic objectives.

Question 13

Critics of purchasing power parity argue that:

Accepted Answer

Critics argue that long-run equilibrium exchange rates are theoretical and may never be attained due to market imperfections, government interventions, and other factors that prevent the full realization of purchasing power parity.

Question 14

Suppose that the rate of inflation in Japan is 1 percent and the rate of inflation in the United States is 3 percent. If the real exchange rate remains constant, the value of the U.S. dollar relative to the yen must:

Accepted Answer

If the real exchange rate remains constant and the inflation rate in the United States is higher than in Japan, the value of the U.S. dollar relative to the yen must decrease to compensate for the higher inflation. The difference in inflation rates is 2 percent (3% - 1%), indicating the U.S. dollar must fall by approximately 2 percent relative to the yen.

Question 15

Suppose 500,000 yen buys a basket of goods in Japan. If, at the existing exchange rate, it costs more than 500,000 yen to buy the same basket of goods in the United States, then purchasing power parity implies that the:

Accepted Answer

The answer of Suppose 500,000 yen buys a basket of...

Question 16

Suppose a given basket of goods and services costs 15 dollars in the United States and 14,250 won in Korea. If the exchange rate is 900 won per dollar, purchasing power parity implies that the:

Accepted Answer

The answer of Suppose a given basket of goods and...

Question 17

Suppose a given basket of goods and services costs 9 dollars in Australia and 5,400 baht in Thailand. If the exchange rate is 600 baht per Australian dollar, purchasing power parity implies that the:

Accepted Answer

Purchasing Power Parity (PPP) implies that in the long run, the exchange rate between two currencies should move towards the rate that equalizes the prices of an identical basket of goods and services in any two countries. In this case, 9 Australian dollars can buy the basket in Australia, and the equivalent in Thailand is 5,400 baht. Given the exchange rate of 600 baht per Australian dollar, 9 Australian dollars convert to 5,400 baht (9 * 600 = 5,400), exactly matching the cost in Thailand. This indicates that the exchange rate has already attained its long-run equilibrium value according to PPP.

Question 18

Suppose a McDonald's Big Mac costs 29 pesos in Mexico, and the exchange rate between the peso and the Canadian dollar is 10 pesos per Canadian dollar. According to purchasing power parity, a Canadian Big Mac should cost:

Accepted Answer

According to purchasing power parity, the cost of goods should be the same in each country when prices are converted into a common currency. Therefore, a Big Mac costing 29 pesos in Mexico would cost 29 pesos / 10 pesos per Canadian dollar = 2.90 Canadian dollars in Canada.

Question 19

The real exchange rate is the exchange rate that:

Accepted Answer

The real exchange rate adjusts the nominal exchange rate by the relative prices of a basket of goods in the two countries, effectively eliminating the effects of inflation differences. This provides a more accurate measure of the exchange rate's purchasing power between two currencies.

Question 20

If a basket of goods costs $10 in the United States and 100,000 rubles in Russia, then purchasing power parity will exist if the exchange rate between the ruble and the dollar is:

Accepted Answer

Purchasing power parity (PPP) implies that the exchange rate should equalize the price of the basket of goods in both countries. If the basket costs $10 in the US and 100,000 rubles in Russia, the exchange rate should be 100,000 rubles per $10, which simplifies to 10,000 rubles per dollar.

Quiz 35: International Financial Policy