Question 1

Exchange-rate overshooting is based on the notion that the supply schedule of a currency is more elastic in the short run than in the long run.

Accepted Answer

Exchange-rate overshooting is based on the notion that prices are sticky in the short run, leading to more significant changes in exchange rates than in the long run, where prices can adjust.

Question 2

The asset-markets approach views exchange-rate determination as similar to the stock market in which prices are volatile and expectations are important.

Accepted Answer

The asset-markets approach indeed views exchange-rate determination as similar to the stock market in which prices are volatile and expectations play a crucial role. This approach emphasizes the role of financial assets and expectations in setting exchange rates.

Question 3

If consumer tastes in the United States change in favor of goods produced in France,the demand for francs will increase which causes an appreciation of the dollar against the franc under a floating exchange rate system.

Accepted Answer

If consumer tastes in the United States change in favor of goods produced in France, there will be an increase in demand for francs, causing the franc to appreciate against the dollar. This is because an increase in demand for francs means that more dollars are being exchanged for francs, which increases the demand for francs relative to the supply. This, in turn, causes the price of francs to increase in terms of dollars, resulting in a depreciation of the dollar against the franc.

Question 4

According to the principle of exchange-rate overshooting,a short-run depreciation of a currency is likely to be greater than a long-run depreciation of that currency.

Accepted Answer

The principle of exchange-rate overshooting suggests that in response to a shock, such as an increase in interest rates or a change in perceived risk, a currency's exchange rate will adjust more in the short-run than in the long-run. This is due to factors such as sticky prices and imperfect market adjustment mechanisms. Therefore, a short-run depreciation of a currency is likely to be greater than a long-run depreciation of that currency.

Question 5

The purchasing- power-parity theory predicts that if the U.S.inflation rate exceeds the Japanese inflation rate by 4 percent,the dollar's exchange value will appreciate by 4 percent against the yen.

Accepted Answer

The purchasing-power-parity theory predicts that if the U.S. inflation rate exceeds the Japanese inflation rate, the dollar's exchange rate against the yen should decline, not appreciate. This is because the purchasing power of the dollar will decrease relative to the yen. Therefore, an increase in the U.S. inflation rate relative to Japan's inflation rate should lead to a decrease in the dollar's value against the yen, not an appreciation.

Question 6

According to the asset-markets approach,adjustments among financial assets are a key determinant of long-run movements in exchange rates.

Accepted Answer

The answer of According to the asset-markets approach,adjustments among financial...

Question 7

According to the "Big Mac" index,if a Big Mac costs $2.28 in the United States and 48 baht in Thailand (equivalent to $1.91),the baht is an undervalued currency.

Accepted Answer

The "Big Mac" index suggests that if a Big Mac is cheaper in one country compared to another, the currency of the cheaper country is undervalued. Here, the Big Mac is cheaper in Thailand, indicating the baht is undervalued.

Question 8

Assume the initial yen/dollar exchange rate to be 100 yen per dollar.If the U.S.inflation rate is 2 percent and the Japanese inflation rate is 7 percent,the exchange rate should move to 105 yen per dollar according to the purchasing-power-parity theory.

Accepted Answer

According to the purchasing-power-parity theory, the exchange rate should move in the direction of the inflation differential, meaning that the yen should weaken relative to the dollar due to the higher Japanese inflation rate. Therefore, the exchange rate should move to 95 yen per dollar, not 105 yen per dollar.

Question 9

In the short run,exchange rates are primarily determined by investor expectations of returns on assets such as government securities and bank accounts.

Accepted Answer

In the short run, exchange rates are primarily driven by capital flows which are driven by expectations of returns on assets such as government securities and bank accounts. These investor expectations can lead to changes in demand and supply for currencies in the foreign exchange market, which in turn impact exchange rates in the short run.

Question 10

If the United States experiences an enormous wheat crop failure,it will have to import more wheat and the dollar's exchange value will depreciate under a system of floating exchange rates.

Accepted Answer

If the US experiences an enormous wheat crop failure and has to import more wheat, this will increase demand for foreign currency to pay for the imports, which will cause the value of the dollar to depreciate under a floating exchange rate system.

Question 11

If Mexico applies tariffs to imports of manufactured goods,Mexico's demand for foreign exchange will rise and the peso will depreciate under a system of floating exchange rates.

Accepted Answer

If Mexico applies tariffs to imports, it would likely reduce the demand for foreign goods, decreasing the demand for foreign exchange, which could lead to an appreciation of the peso under a floating exchange rate system.

Question 12

According to exchange-rate overshooting,an appreciation of the Australian dollar is likely to be greater over a long time period than over a short time period.

Accepted Answer

Exchange-rate overshooting suggests that in response to a shock, exchange rates will initially overadjust (overshoot) and then gradually move back to their long-term equilibrium level, implying a larger initial change followed by a correction rather than a greater change over a long period.

Question 13

As the profitability of Japanese assets rises relative to the profitability of Australian assets,Australian residents will make additional investments in Japan; this results in an increased demand for yen and a depreciation of the dollar under a system of floating exchange rates.

Accepted Answer

This is because as Australian residents invest more in Japanese assets, they need to buy yen to make those investments, increasing the demand for yen and leading to a depreciation of the Australian dollar in the currency markets.

Question 14

Long-run determinants of exchange rate include labor productivity levels,inflation rates,consumer preferences for goods and services,and trade barriers.

Accepted Answer

These factors are considered to be long-run determinants of exchange rates as they can influence the demand for a country's currency over time. Labor productivity levels can affect a country's competitiveness and export potential, while inflation rates can impact the value of a currency relative to others. Consumer preferences for goods and services can affect the balance of trade, and trade barriers can impact the flow of goods and services between countries.

Question 15

If it is widely expected that the British economy will experience more rapid inflation than the Australian economy,the pound will depreciate against the dollar under a system of floating exchange rates.

Accepted Answer

If inflation is expected to be higher in the UK compared to Australia, investors will demand a higher return on investments in the UK to compensate for the higher inflation rate. This will lead to a decrease in demand for the pound, causing its value to depreciate relative to the dollar under a floating exchange rate system.

Question 16

Changes in market expectations have their greatest impact on exchange-rate changes over the long run as opposed to the short run.

Accepted Answer

Changes in market expectations can have immediate effects on exchange rates in the short run due to speculation and rapid adjustments in investment flows, whereas long-run exchange rate changes are more influenced by fundamental economic factors such as inflation rates, interest rates, and economic growth.

Question 17

According to the law of one price,identical goods should cost the same in all nations,assuming there are no shipping costs nor trade barriers.

Accepted Answer

The law of one price suggests that the price of identical goods in different nations should be the same, assuming there are no trade barriers and transportation costs involved. This principle is based on the idea of arbitrage, where individuals could potentially make a profit by buying a product in a country where it is cheaper and selling it in a country where it is more expensive. However, in reality, there may be other factors that impact the pricing of goods in different nations, such as taxes or different levels of demand.

Question 18

According to the "Big Mac" index,if a Big Mac costs $2.28 in the United States and 25.75 krone in Denmark (equivalent to $4.25),the Danish krone is an undervalued currency.

Accepted Answer

The Big Mac index is used to compare the purchasing power parity (PPP) between different countries. If the price of a Big Mac is higher in one country than another, the currency of the country with the more expensive Big Mac is considered overvalued. Conversely, if the price of a Big Mac is lower in one country than another, the currency of the country with the cheaper Big Mac is considered undervalued. In this case, the price of a Big Mac is higher in Denmark than in the US, which means that the Danish krone is overvalued, not undervalued as the statement suggests.

Question 19

If Japan realizes technological improvements in the production of automobiles,which lowers its production costs relative to foreign producers,Japanese exports will rise and the yen's exchange value will appreciate under a system of floating exchange rates.

Accepted Answer

If Japan's production costs decrease, it can lower the prices of its exports, making them more competitive and increasing their demand. This, in turn, increases the demand for Japanese yen in foreign exchange markets, causing the yen's value to appreciate.

Question 20

Assume the initial dollar/pound exchange rate to be $2 per pound.If the U.S.inflation rate is 8 percent and the U.K.inflation rate is 3 percent,the exchange rate should move to $2.10 per pound according to the purchasing-power-parity theory.

Accepted Answer

According to the purchasing-power-parity theory, the exchange rate should adjust to reflect the relative changes in inflation rates. Since the U.S. has a higher inflation rate than the U.K., the dollar should depreciate relative to the pound, causing the exchange rate to move from $2 to $2.10 per pound. Therefore, the statement is true.

Quiz 12: Exchange Rate Determination