The Balassa-Samuelson effect states that when a nation's productivity rises relative to its trading partners, its wages and prices rise and its real exchange rate:
A) depreciates.
B) converges to 1.
C) appreciates.
D) exhibits instability over a short period.

Question

Quizplus · Accepted Answer

The Balassa-Samuelson effect states that a nation with higher productivity will have higher wages and prices, which will lead to an appreciation of their real exchange rate. This is because the productivity gains in the traded goods sector will spill over to non-traded goods and services, driving up their prices as well. Therefore, the correct answer is C, which states that the nation's real exchange rate appreciates.

The Balassa-Samuelson Effect States That When a Nation's Productivity Rises