Question 1

The monetary approach makes the general prediction that
A) the exchange rate, which is the relative price of American and European money, is fully determined in the long run by the relative supplies of those monies.
B) the exchange rate, which is the relative price of American and European money, is fully determined in the short run by the relative supplies of those monies and the relative demands for them.
C) the exchange rate, which is the relative price of American and European money, is fully determined in the short run and long run by the relative supplies of those monies and the relative demands for them.
D) the exchange rate, which is the relative price of American and European money, is fully determined in the long run by the relative supplies of those monies and the relative demands for them.
E) the money supply in the U.S. will adjust to European monetary equilibrium.

Accepted Answer

The monetary approach argues that in the long run, the exchange rate is fully determined by the relative supplies of American and European money and the relative demands for them. It does not make specific predictions about the short run determination of exchange rates, but generally considers that there may be short run fluctuations due to changes in the expectations, risk perceptions, and other factors that affect the demand for and supply of currencies. Therefore, choice D is the best option as it captures the core prediction of the monetary approach while recognizing that short run factors may also play a role in exchange rate fluctuations.

Question 2

Explain the Law of One Price. Give an example.

Accepted Answer

The law of one price states that in competitive markets free of transportation costs and trade barriers, identical goods sold in different countries must sell for the same price when expressed in terms of the same currency.
  If, for example, the price of the same sweater was cheaper in London than in New York, U.S. importers and British exporters would have an incentive to buy sweaters in London and ship them to New York, pushing the London price up and the New York price down, until both were equal.

Question 3

Which of the following statements is the most accurate?
A) The law of one price applies only to the general price level.
B) The law of one price applies to the general price level while PPP applies to individual commodities.
C) The law of one price applies to individual commodities while PPP applies to both the general price level and to individual commodities.
D) PPP applies only to individual commodities.
E) The law of one price applies to individual commodities while PPP applies to the general price level.

Accepted Answer

The law of one price applies to individual commodities, ensuring that identical goods sell for the same price in different locations when there are no transportation costs or trade barriers. Purchasing Power Parity (PPP) applies to the general price level, comparing the relative value of currencies based on the cost of a basket of goods.

Question 4

Under the monetary approach to the exchange rate theory, money supply growth at a constant rate
A) eventually results in ongoing price level deflation at the same rate, but changes in this long-run deflation rate do not affect the full-employment output level or the long-run relative prices of goods and services.
B) eventually results in ongoing price level inflation at the same rate, but changes in this long-run inflation rate do affect the full-employment output level and the long-run relative prices of goods and services.
C) eventually results in ongoing price level inflation at the same rate, but changes in this long-run inflation rate do not affect the full-employment output level or the long-run relative prices of goods and services.
D) eventually results in ongoing price level inflation at the same rate, but changes in this long-run inflation rate do not affect the full-employment output level, only the long-run relative prices of goods and services.
E) eventually results in ongoing price level deflation at the same rate, but changes in this long-run deflation rate do not affect the full-employment output level, only the long-run relative prices of goods and services.

Accepted Answer

According to the monetary approach to the exchange rate theory, money supply growth at a constant rate eventually results in ongoing price level inflation at the same rate, but changes in this long-run inflation rate do not affect the full-employment output level or the long-run relative prices of goods and services. Therefore, the correct choice is C.

Question 5

Which of the following statements is the most accurate? The law of one price states:
A) in competitive markets free of transportation costs and official barrier to trade, identical goods sold in different countries must sell for the same price when their prices are expressed in terms of the same currency.
B) in competitive markets free of transportation costs and official barrier to trade, identical goods sold in the same country must sell for the same price when their prices are expressed in terms of the same currency.
C) in competitive markets free of transportation costs and official barrier to trade, identical goods sold in different countries must sell for the same price.
D) identical goods sold in different countries must sell for the same price when their prices are expressed in terms of the same currency.
E) in competitive markets free of official barrier to trade, identical goods are sold at the same price regardless of transportation costs.

Accepted Answer

The law of one price states that in a competitive market free of transportation costs and official barriers to trade, identical goods sold in different countries must sell for the same price when their prices are expressed in terms of the same currency. This means that if there are no legal or transportation barriers to international trade, goods should have the same price regardless of their location.

Question 6

Discuss the differences between Absolute PPP and Relative PPP.

Accepted Answer

The answer of Discuss the differences between Absolute PPP and...

Question 7

Explain why Relative PPP is useful when comparing countries that base their price levels on different product baskets.

Accepted Answer

The answer of Explain why Relative PPP is useful when...

Question 8

Under Purchasing Power Parity,
A) 
B) 
C) 
D) 
E)

Accepted Answer

Purchasing Power Parity is the theory that exchange rates should adjust so that the same basket of goods costs the same amount in different countries. Choice A is the closest to this definition as it does not mention any other economic theories or concepts.

Question 9

Assuming relative PPP, fill in the table below:

Accepted Answer

The answer of Assuming relative PPP, fill in the table...

Question 10

Explain Purchasing Power Parity.

Accepted Answer

The answer of Explain Purchasing Power Parity....

Question 11

Discuss the relationship between PPP and the Law of One Price.

Accepted Answer

The answer of Discuss the relationship between PPP and the...

Question 12

In order for the condition E_$/HK$ = P_US/P_HK to hold, what assumptions does the principle of purchasing power parity make? A) Only that there are no transportation costs and restrictions on trade. B) Only that the markets are perfectly competitive, i.e., P = MC. C) The factors of production are identical between countries. D) No arbitrage exists. E) HK and US are perfectly competitive and there are no transportation costs or restrictions on trade.

Accepted Answer

The principle of purchasing power parity assumes that markets are perfectly competitive and there are no transportation costs or restrictions on trade, which is encapsulated in option E.

Question 13

Which of the following statements is the most accurate?
A) Absolute PPP does not imply relative PPP.
B) Relative PPP implies absolute PPP.
C) There is no causality relation between the two.
D) Absolute PPP implies relative PPP.
E) Absolute PPP is inversely related to relative PPP.

Accepted Answer

Absolute PPP implies relative PPP because if absolute PPP holds, then the price levels between two countries are equal when expressed in a common currency, which inherently means that the rate of change in prices (inflation) between the two countries will also be equal, satisfying relative PPP.

Question 14

Which of the following statements is the most accurate?
A) Relative PPP may be valid even when absolute PPP is not, provided the factors causing deviations from absolute PPP are more or less stable over different commodities space.
B) Absolute PPP may be valid even when relative PPP is not, provided the factors causing deviations from relative PPP are more or less stable over time.
C) Relative PPP may be valid even when absolute PPP is not, provided the factors causing deviations from absolute PPP are more or less stable over time.
D) Relative PPP is not valid when absolute PPP is not.
E) Relative PPP is only valid when absolute PPP is valid, providing the factors causing deviations from relative PPP are more or less stable over time.

Accepted Answer

The answer of Which of the following statements is the...

Question 15

Which of the following statements is the most accurate?
A) If PPP holds true, then the law of one price holds true for every commodity as long as the reference baskets used to reckon different countries' price levels are the same.
B) If the law of one price holds true for every commodity, PPP must hold automatically.
C) If the law of one price holds true for every commodity, PPP must automatically hold as long as the reference baskets used to reckon different countries' price levels are the same.
D) If the law of one price does not hold true for every commodity, PPP cannot be true as long as the reference baskets used to reckon different countries' price levels are the same.
E) If PPP holds true, then the law of one price must hold true automatically.

Accepted Answer

The statement in option C is the most accurate because it acknowledges the necessary condition that the reference baskets used to calculate different countries' price levels need to be the same for PPP to hold true. The law of one price states that the same good should sell for the same price in different markets, whereas PPP is an equilibrium condition that relates exchange rates to price levels across countries. If the law of one price holds true for every commodity, it means that there are no arbitrage opportunities left for traders to profit from price differentials. However, if the reference baskets used to calculate price levels are different between countries, then the exchange rate derived from the law of one price may not be the same as the one required for PPP to hold true. Therefore, option C is the most accurate because it specifies the condition that must hold for PPP to be supported by the law of one price.

Question 16

Fill in the following table, assuming the law of one price prevails.

Accepted Answer

The answer of Fill in the following table, assuming the...

Question 17

Suppose Russia's inflation rate is 200% over one year but the inflation rate in Switzerland is only 2%. According to relative PPP, what should happen over the year to the Swiss franc's exchange rate against the Russian ruble?

Accepted Answer

The answer of Suppose Russia's inflation rate is 200% over...

Question 18

Which of the following statements is the most accurate?
A) In the long run, national price levels play a minor role in determining both interest rates and the relative prices at which countries' products are traded.
B) In the long run, national price levels play a key role only in determining interest rates.
C) In the long run, national price levels play a key role only in determining the relative prices at which countries' products are traded.
D) In the long run, national price levels play a key role in determining both interest rates and the relative prices at which countries' products are traded.
E) In the long run, national price levels play no role in determining interest rates and the relative prices at which countries' products are traded.

Accepted Answer

In the long run, national price levels play a key role in determining both interest rates and the relative prices at which countries' products are traded. This is because in the long run, inflation rates and currency exchange rates are both affected by national price levels, which in turn affect interest rates and the relative prices of products in international trade. Therefore, option D is the most accurate statement. Options A, B, and C are incorrect as they either underestimate or overestimate the role of national price levels in determining interest rates and relative prices. Option E is also incorrect as national price levels do indeed have an impact on these economic factors.

Question 19

Which of the following statements is the most accurate? In general,
A) the monetary approach to the exchange rate is a long run theory.
B) the monetary approach to the exchange rate is a short run theory.
C) the monetary approach to the exchange rate is both a short and long run theory.
D) the monetary approach to the exchange rate neither long run nor short run theory.
E) the monetary approach to the exchange rate is considered less practical than the law of one price.

Accepted Answer

The monetary approach to the exchange rate is primarily a long-run theory, as it focuses on the relationship between money supply, price levels, and exchange rates over time.

Question 20

Under Purchasing Power Parity,
A) 
B) 
C) 
D) 
E)

Accepted Answer

The answer of Under Purchasing Power Parity,
A) 
B) 
C) 
D)...

Quiz 16: Price Levels and the Exchange Rate in the Long Run

The monetary approach makes the general prediction that

Explain the Law of One Price. Give an example.

Which of the following statements is the most accurate?

Under the monetary approach to the exchange rate theory, money supply growth at a constant rate

Which of the following statements is the most accurate? The law of one price states:

Discuss the differences between Absolute PPP and Relative PPP.

Explain why Relative PPP is useful when comparing countries that base their price levels on different product baskets.

Under Purchasing Power Parity,

Assuming relative PPP, fill in the table below:

Explain Purchasing Power Parity.

Discuss the relationship between PPP and the Law of One Price.

In order for the condition E$/HK$ = PUS/PHK to hold, what assumptions does the principle of purchasing power parity make?

Which of the following statements is the most accurate?

Which of the following statements is the most accurate?

Which of the following statements is the most accurate?

Fill in the following table, assuming the law of one price prevails.

Suppose Russia's inflation rate is 200% over one year but the inflation rate in Switzerland is only 2%. According to relative PPP, what should happen over the year to the Swiss franc's exchange rate against the Russian ruble?

Which of the following statements is the most accurate?

Which of the following statements is the most accurate? In general,

Under Purchasing Power Parity,

In order for the condition E_$/HK$ = P_US/P_HK to hold, what assumptions does the principle of purchasing power parity make?