Question 1

According to The Economist magazine's Big Mac index,one of the most overvalued currencies as of July 2008 was the Norwegian kroner.Which of the following is a likely implication of that fact?

Accepted Answer

The Big Mac index compares the prices of a McDonald's Big Mac burger in different countries to determine the relative value of currencies. Therefore, if the Norwegian kroner is overvalued according to this index, it suggests that goods and services in Norway are more expensive than in the U.S.

Question 2

In economics,what does CPI stand for?

Accepted Answer

CPI stands for Consumer Price Index, which is a measure of the average change over time in the prices paid by consumers for a market basket of goods and services. It is one of the most widely used indicators of inflation in an economy. A is incorrect because there is no such term as Continuous Price Inflation, B is incorrect because Central Price Information does not exist in economics, and D is incorrect because Collateral Price Inflation is not a commonly used term in economics.

Question 3

Changes in relative prices occur when

Accepted Answer

Relative prices refer to the prices of different goods or services in comparison to each other. When the prices of these goods or services change at different rates, there are changes in relative prices. A and B are incorrect because they suggest that all prices or exchange rates move together, which is not necessarily the case. D is also incorrect as it assumes that exchange rate appreciation and price appreciation are always linked, which is not necessarily true.

Question 4

We expect that in the long run,exchange rate movements will largely reflect inflation differentials.

Accepted Answer

Because real events causing relative price movements are often random and short run in nature.

Question 5

If the price of Big Mac is $3.61 in the U.S.and 3.405 € in France,and PPP holds,what is the value of the euro in dollars that is implied by The Economist magazine's Big Mac index?
A)$1.060
B)$0.943
C)$1.943
D)None of the above.

Accepted Answer

The answer of If the price of Big Mac is...

Question 6

For which of the following is the law of one price least likely to hold?

Accepted Answer

The law of one price states that in the absence of transaction costs and assuming perfect information, identical goods should have the same price when prices are expressed in a common currency. The law is least likely to hold for non-homogeneous goods or services that cannot be easily traded across locations, such as haircuts. Unlike gold, US Treasury Bonds, and petroleum, which are homogeneous and traded globally, haircuts are services that are highly localized and vary significantly in quality and style, making the law of one price less applicable.

Question 7

Which of the following is correct?

Accepted Answer

All statements are correct. A) Exchange rates can fluctuate significantly in the short term due to market sentiment, speculation, and other factors, making them more variable than inflation differentials. B) Purchasing Power Parity (PPP) deviations are more noticeable in shorter time frames like monthly data due to short-term fluctuations in exchange rates and prices. C) PPP tends to hold best in the long run as prices and exchange rates adjust to reflect changes in inflation and purchasing power between countries.

Question 8

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

Accepted Answer

This statement is true as short-term fluctuations in exchange rates are often driven by factors such as changes in market sentiment, geopolitical events, and shifts in capital flows, which can cause rapid and significant movements in currency values. In contrast, inflation differentials tend to change at a more gradual pace and are influenced by factors such as domestic economic conditions, government policy, and global commodity prices.

Question 9

The higher the inflation differential between countries,the less likely it is that relative PPP will hold.

Accepted Answer

The answer of The higher the inflation differential between countries,the...

Question 10

PPP holds better for low-inflation countries.

Accepted Answer

Opposite, in high-inflation countries changes in exchange rates are highly correlated with inflation differentials because the sheer magnitude of inflation overwhelms the relative price effects.

Question 11

If relative PPP held,then the real exchange rate must be equal to one.

Accepted Answer

If relative PPP held, then the real exchange rate must be equal to a constant number.

Question 12

If absolute PPP holds,then the real exchange rate must equal 1.

Accepted Answer

If absolute PPP holds, then it means that the price levels of two countries are equalized through the exchange rate. In other words, the same basket of goods should cost the same in different countries after converting their currencies. Therefore, the real exchange rate should be equal to 1, indicating that the nominal exchange rate fully reflects the relative purchasing power of currencies.

Question 13

The more homogeneous goods are,the more we expect the law of one price to hold.

Accepted Answer

It is expected to hold better for homogeneous goods.

Question 14

Suppose a year ago the exchange rate between Mexican pesos and dollars was 13.5 pesos per dollar,and that according to relative PPP the exchange rate was in equilibrium.Furthermore,assume that since then,Mexican inflation has been 12 percent while the U.S.inflation has been 3 percent.If according to relative PPP the peso is now said to be overvalued,what is a possible exchange rate consistent with this assertion?

Accepted Answer

The answer of Suppose a year ago the exchange rate...

Question 15

Studies of PPP covering many years will be more likely to yield evidence of PPP than studies based on short-run data.

Accepted Answer

The longer time frame will allow for more inflation so that the random relative price effects are relatively unimportant and we find exchange rate changes closely related to inflation differentials.

Question 16

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

Accepted Answer

If the levels of the variables (prices and exchange rates)hold, then changes in these variables should hold as well. But, not vice-versa.

Question 17

The only reason that exchange rates change is because overall price levels in the countries change.

Accepted Answer

Relative price changes, in addition to inflation, can change the exchange rates.

Question 18

PPP is a theory of real exchange rate determination.

Accepted Answer

It is only an equilibrium relationship between two endogenous variables. Prices and exchange rates are simultaneously determined by other factors such that the former do not cause the latter to change.

Question 19

Endogenous variables tend to be less volatile than exogenous ones.

Accepted Answer

Endogenous variables are determined within the model and can be highly volatile as they respond to changes in other variables within the system, whereas exogenous variables are external and do not change in response to the model's dynamics, making them less volatile in the context of the model's behavior.

Question 20

If the law of one price holds for a single good,then absolute PPP measured with price indexes will also hold.

Accepted Answer

Since consumers in different countries consume different goods, price indexes are not directly comparable internationally. Thus using price indexes to measure PPP creates problems and causes deviations from PPP.

Quiz 15: Exchange Rates in the Long Run