Question 1

If prices in the U.S. rise faster than prices in the United Kingdom, then according to the doctrine of purchasing-power parity the U.S. nominal exchange rate should rise

Accepted Answer

According to the doctrine of purchasing-power parity, if prices in the U.S. rise faster than prices in the United Kingdom, then the U.S. dollar should depreciate relative to the British pound to restore equilibrium in the prices of goods and services between the two countries. Therefore, the U.S. nominal exchange rate should fall, not rise.

Question 2

Many economists believe that the theory of purchasing-power parity describes the forces that determine exchange rates in the long run.

Accepted Answer

The theory of purchasing-power parity suggests that exchange rates should adjust to equalize the prices of identical tradable goods and services in different countries, and many economists believe this theory holds true in the long run.

Question 3

The theory of purchasing-power parity states that a unit of a country's currency should be able to buy the same quantity of goods in foreign countries as it does in the domestic economy.

Accepted Answer

The theory of purchasing-power parity (PPP) is based on the idea that exchange rates should adjust so that the price of a basket of goods is the same in different countries. In other words, if the price of a basket of goods in one country is higher than in another country, the exchange rate should adjust so that the goods are equally affordable in both countries. This concept suggests that exchange rates should be a reflection of the relative cost of living and inflation rates between two countries.

Question 4

Purchasing-power parity says that the nominal exchange rate must equal the real exchange rate.

Accepted Answer

Purchasing-power parity (PPP) theory states that in the long run, exchange rates should adjust so that the same basket of goods costs the same amount in two different countries when priced in the same currency. It does not imply that the nominal exchange rate must equal the real exchange rate; rather, it suggests that the real exchange rate should approach parity (equality in purchasing power) over time.

Question 5

When the central bank of some country prints large quantities of money, that county's currency loses value both in terms of the goods and services it buys and in terms of the amount of foreign currencies it can buy.

Accepted Answer

When a central bank prints large quantities of money, it increases the supply of that currency in circulation. This leads to inflation, which means the currency loses value in terms of the goods and services it can buy. Additionally, other countries may see the increased supply of the currency as a sign of economic weakness and may demand more foreign currency in exchange for the depreciating currency, leading to a decrease in its foreign exchange value.

Question 6

If U.S. residents purchase $450 billion of foreign assets and foreigners purchase $575 billion of U.S. assets, then the U.S. has net capital outflows of -$125 billion and a trade deficit of $125 billion.

Accepted Answer

Net capital outflows equal the difference between U.S. residents' purchases of foreign assets ($450 billion) and foreigners' purchases of U.S. assets ($575 billion), which is -$125 billion. This means that there is a trade deficit of $125 billion, as the U.S. is importing more than it is exporting.

Question 7

In the 1970s and 1980s the U.S. dollar depreciated against the German mark and appreciated against the Italian lira because U.S. inflation was lower than in Germany but higher than in Italy.

Accepted Answer

The U.S. dollar would depreciate against a currency from a country with lower inflation and appreciate against a currency from a country with higher inflation, due to the purchasing power parity theory.

Question 8

If foreign residents purchase 30 billion pesos of Mexican assets and Mexican residents purchase 25 billion pesos of foreign assets, then Mexico has a net capital outflow of 5 billion pesos.

Accepted Answer

The net capital outflow is calculated by subtracting foreign purchases of Mexican assets from Mexican purchases of foreign assets. Thus, Mexico has a net capital inflow of 5 billion pesos (25 billion pesos of foreign assets purchased by Mexicans minus 30 billion pesos of Mexican assets purchased by foreigners equals -5 billion pesos, which when multiplied by -1 gives a net capital inflow of 5 billion pesos).

Question 9

If over the next year the inflation rate in the euro area is higher than the inflation rate in Japan, then the euro should depreciate relative to the Japanese yen.

Accepted Answer

If the inflation rate in the euro area is higher than in Japan, the euro will lose purchasing power relative to the yen, and hence will depreciate.

Question 10

If the U.S. real exchange rate is greater than 1, then there is the possibility of arbitraging by buying foreign goods to sell in the U.S.

Accepted Answer

When the U.S. real exchange rate is greater than 1, it means that the U.S. dollar is relatively strong compared to foreign currencies. This creates an opportunity for individuals or businesses to buy foreign goods at a lower cost and sell them in the U.S. for a higher price, earning a profit on the exchange rate difference. This is known as arbitrage.

Question 11

Other things the same, an increase in the U.S. real exchange rate makes U.S. goods more expensive relative to foreign goods.

Accepted Answer

An increase in the U.S. real exchange rate means that the value of the U.S. dollar has strengthened relative to other currencies. This means that U.S. goods will cost more in foreign currency terms, making them more expensive relative to foreign goods.

Question 12

If the purchasing power of the dollar is always the same at home and abroad, then the nominal exchange rate defined as units of foreign currency per dollar decreases if the U.S. price level rises more than the price level in foreign countries.

Accepted Answer

If the purchasing power of the dollar remains constant, then an increase in the U.S. price level relative to foreign countries would mean that a dollar can buy fewer goods in the U.S. than abroad. This would make the foreign currency more valuable and would lead to a decrease in the nominal exchange rate.

Question 13

Other things the same, an increase in domestic prices raises the real exchange rate.

Accepted Answer

An increase in domestic prices will lead to an increase in the relative price level of domestic goods, causing a rise in the real exchange rate. This is because the increase in domestic prices will make domestic goods relatively more expensive compared to foreign goods, leading to an increase in demand for foreign goods and a decrease in demand for domestic goods, which then causes the real exchange rate to appreciate.

Question 14

According to purchasing-power parity theory, the nominal exchange rate between the U.S. and another country should equal the U.S. price level divided by the price level in the foreign country.

Accepted Answer

According to purchasing-power parity (PPP) theory, the nominal exchange rate between two countries should equal the ratio of the foreign price level to the U.S. price level, not the U.S. price level divided by the foreign price level.

Question 15

Other things the same, an increase in the real exchange rate raises U.S. net exports.

Accepted Answer

An increase in the real exchange rate makes U.S. goods relatively more expensive to foreign buyers, which reduces net exports (exports minus imports).

Question 16

Other things the same, an increase in foreign prices raises the real exchange rate.

Accepted Answer

An increase in foreign prices relative to domestic prices would actually lower the real exchange rate, making domestic goods relatively more expensive compared to foreign goods.

Question 17

Jason plans to buy shrimp in Florida and sell them in Manhattan, Kansas where the price is higher. Jason plans to engage in arbitrage.

Accepted Answer

Engaging in arbitrage involves buying a good at a lower price in one market and then selling it at a higher price in another market. Therefore, Jason's plan to buy shrimp in Florida and sell them in Manhattan, Kansas where the price is higher qualifies as arbitrage.

Question 18

If prices in Mexico rise at a higher rate than prices in the U.S., then according to purchasing-power parity the U.S. nominal exchange rate with Mexico should rise.

Accepted Answer

The answer of If prices in Mexico rise at a...

Question 19

According to purchasing power parity, the nominal exchange rate between the U.S. and another country should equal the price level of foreign goods divided by the price level of U.S. goods.

Accepted Answer

This is the basic equation of purchasing power parity (PPP), which states that the exchange rate between two currencies should reflect the relative price levels of their respective economies.

Question 20

Other things the same, an increase in the foreign price level leads to an increase in the real exchange rate.

Accepted Answer

An increase in the foreign price level, other things being equal, would decrease the real exchange rate, as the real exchange rate is the relative price of domestic goods in terms of foreign goods. Higher foreign prices make foreign goods more expensive relative to domestic goods.

Quiz 31: Open-Economy Macroeconomics: Basic Concepts