Deck 14: Exchange Rates I: the Monetary Approach in the Long Run

Question 1

The idea that with frictionless trade all goods traded internationally will have the same equilibrium price no matter which currency they are priced in is known as:

A) covered interest parity.
B) arbitrage.
C) the law of one price.
D) relativity.

Answer 1

C

Question 2

If a pair of Nike shoes cost $45 in New York and $65 in Berlin, then we would expect the price to:

A) drop in New York and increase in Berlin.
B) remain the same in both places.
C) increase in New York and decrease in Berlin.
D) increase in Berlin and stay constant in New York.

Answer 2

C

Question 3

Purchasing power parity exists when: I. there are no arbitrage opportunities.
II) prices are the same when expressed in a common currency.
III) the goods in question are identical.

A) I only
B) I and II only
C) II and III only
D) I, II, and III

Answer 3

D

Question 4

The real exchange rate between two currencies tells us:

A) changes in the exchange rate over time.
B) how many units of one currency can be purchased with one unit of the home currency.
C) how much in terms of goods and services the home currency will buy in the foreign nation compared with the home nation.
D) how much depreciation or appreciation has occurred in the home exchange rate.

Question 5

If a real exchange rate depreciation occurs, which of the following results?

A) It takes more home goods to purchase the same quantity of foreign goods.
B) It takes fewer home goods to purchase the same quantity of foreign goods.
C) The nominal exchange rate has risen as well.
D) The nominal exchange rate has fallen.

Question 6

In equilibrium, all traded goods sell at the same price internationally because of:

A) government direction.
B) arbitrage.
C) markets in which buyers and sellers do not interact.
D) the fact that the underlying value is the same everywhere.

Question 7

In equilibrium, all traded goods sell at the same price internationally. If the same goods are expressed in their home prices, then the ratio of the prices is equal to:

A) one.
B) zero.
C) the rate of interest.
D) the nominal exchange rate between the two currencies.

Question 8

If an automobile costs $32,000 in New York and $1 = 0.8 euros, then under the condition of the law of one price, the cost of the automobile in Rome should be:

A) 32,000 euros.
B) 40,000 euros.
C) 35,000 euros.
D) 25,600 euros.

Question 9

The relative purchasing power of a currency is:

A) the exchange rate expressed in ounces of gold.
B) the value of one currency in terms of the goods and services a unit will purchase compared with an equivalent amount of another currency.
C) the official value of one nation's currency compared with the official value of another currency.
D) the value of the currency during an economic expansion compared with its value during a recession.

Question 10

The monetary approach to exchange rates describes:

A) long-run relationships between money, prices, and exchange rates.
B) a short-run relationship between exchange rates and interest rates.
C) a short-run measure of fluctuations in exchange rates.
D) a theory based on the idea that exchange rates are constant in the long run.

Question 11

The law of one price requires:

A) trade frictions.
B) perfect competition.
C) trade frictions and perfect competition.
D) neither trade frictions nor perfect competition.

Question 12

If a pound of coffee beans costs 85 pesos in Mexico City and 10 pesos = 35 rupees, then the same pound of coffee should cost _________ rupees in New Delhi, under the condition of the law of one price.

A) 300
B) 297.50
C) 29,750
D) 3,500

Question 13

In the international goods market, prices of goods in different countries expressed in a common currency must be equalized. This concept is called:

A) exchange rate theory.
B) the law of one price.
C) appreciation.
D) purchasing power parity (PPP).

Question 14

When the price of a good in the United States is $2, while in Spain it is €2, and the nominal exchange rate is E_$/€ = 1.5, what is the relative price of the good in Spain versus the United States?

A) 1
B) 1.5
C) 2/3
D) 1/2

Question 15

The law of one price works under some assumptions. Which of the following is NOT an assumption for the law of one price?

A) There is free competition.
B) There is no transportation cost.
C) There are no tariffs.
D) The skill level of workers is identical in both countries.

Question 16

If a basket of goods in the United States costs $1,000, and the same basket of goods in Japan costs ¥125,000, then for PPP to exist, $1 should trade for ____ Japanese yen.

A) 4
B) 50
C) 125
D) 125,000

Question 17

While the law of one price relates prices on individual goods to the exchange rate, the theory of PPP relates:

A) the relative price level of a basket of goods to the exchange rate.
B) prices of individual goods to consumer demand.
C) exchange rates to interest rates.
D) goods markets to the market for services.

Question 18

The nominal exchange rate between two currencies tells us:

A) changes in the exchange rate over time.
B) how many units of one currency can be purchased with one unit of the home currency.
C) how much in terms of goods and services the home currency will buy in the foreign nation compared with the home nation.
D) how much depreciation or appreciation has occurred in the home exchange rate.

Question 19

Absolute purchasing power parity implies that:

A) the price of a basket of goods is cheaper in one country than in another.
B) the price of a basket of goods is more expensive in one country than in another.
C) the price of a basket of goods is the same in the two countries.
D) the exchange rate is artificially held constant.

Question 20

When the relative price of a good in Germany versus the United States is 3, if the nominal exchange rate is E_$/€ = 1.5 and the U.S. price is $10, what is the German price?

A) €4
B) €15
C) €20
D) €45

Question 21

In equilibrium, with purchasing power parity, the nominal exchange rate will be equal to:

A) the two nations' real exchange rate.
B) the ratio of the two nations' GDPs.
C) the ratio of the two nations' price levels.
D) one.

Question 22

With relative PPP, a rise in a nation's inflation rate is always offset by an increase in the rate of __________ of its currency.

A) appreciation
B) revaluation
C) depreciation
D) devaluation

Question 23

What is the situation when a home currency purchases fewer goods and services at home than abroad when converted to a foreign currency?

A) The domestic currency is undervalued.
B) The domestic currency is overvalued.
C) The domestic currency is unstable.
D) The domestic currency is appreciating.

Question 24

Absolute PPP and relative PPP differ in what way?

A) Absolute PPP always holds but relative PPP may not.
B) Relative PPP may hold even when absolute PPP does not.
C) Relative and absolute PPP always hold.
D) Absolute PPP relates to changes in inflation and exchange rates, whereas relative PPP relates to their levels.

Question 25

Whenever two nations experience inflation, and the nominal exchange rates move by the same percentage to offset, we say there is:

A) absolute PPP.
B) indeterminate PPP.
C) inverted PPP.
D) relative PPP.

Question 26

Which of the following situations would exhibit relative PPP?

A) Europe's yearly inflation rate rises from 5% to 7%, ceteris paribus, and the euro-yen rate depreciates by 7%.
B) Europe's yearly inflation rate rises from 5% to 7%, ceteris paribus, and the euro-yen rate depreciates by 2%.
C) Europe's yearly inflation rate rises from 5% to 7%, ceteris paribus, and the euro-yen rate appreciates by 2%.
D) Europe's yearly inflation rate rises from 5% to 7%, ceteris paribus, and the euro-yen rate appreciates by 5%.

Question 27

D) 1/PPP.

Question 28

When the Japanese inflation rate is less than the Australian inflation rate, Japanese prices are:

A) rising faster than Australian prices.
B) rising more slowly than Australian prices.
C) rising at the same rate as Australian prices.
D) not rising.

Question 29

What is the situation when a home currency purchases more goods and services at home than abroad when converted to a foreign currency?

A) The domestic currency is undervalued.
B) The domestic currency is overvalued.
C) The domestic currency is unstable.
D) The domestic currency is depreciating.

Question 30

Whenever the absolute purchasing power of two currencies is the same, the real exchange rate between them is equal to:

A) zero.
B) one.
C)

Question 31

If a nation experiences 10% inflation and its trading partner does not, and if PPP holds, what happens to its nominal exchange rate?

A) It depreciates by 10%.
B) It appreciates by 10%.
C) It does not change.
D) It becomes negative.

Question 32

If the prices of goods in Europe increase, while the nominal exchange rate between the euro and the U.S. dollar remains the same, we say that the U.S. dollar has experienced a:

A) nominal appreciation.
B) nominal depreciation.
C) real appreciation.
D) real depreciation.

Question 33

If a nation experiences 10% inflation and its trading partner does not, and if PPP holds, what happens to its real exchange rate?

A) It depreciates by 10%.
B) It appreciates by 10%.
C) It does not change.
D) It becomes negative.

Question 34

If more home goods are required to buy the same amount of foreign goods, then we say that foreign currency has experienced a:

A) nominal appreciation.
B) nominal depreciation.
C) real appreciation.
D) real depreciation.

Question 35

When the inflation rate in any nation changes, ceteris paribus:

A) only absolute PPP is disturbed.
B) only relative PPP is disturbed.
C) both absolute and relative PPP are disturbed.
D) the inflation rates in other nations will have to change as well.

Question 36

Evidence on the existence of relative PPP shows that:

A) the evidence for relative PPP is scanty and the theory is largely discredited.
B) the evidence for relative PPP is hit or miss, and so one should exercise caution in using relative PPP to predict changes in a nation's exchange rates.
C) relative PPP is an approximate guide to predicting the relationship between changes in inflation and exchange rates over long periods, such as decades.
D) both absolute and relative PPP hold nearly perfectly in the short and long run, and are used with great accuracy to make predictions.

Question 37

Under what circumstances would there be a "no-arbitrage" situation in goods markets between two nations?

A) when one of the currencies is undervalued
B) when one of the currencies is overvalued
C) when both of the currencies are overvalued
D) when the relative price of the currencies is equal to one

Question 38

If fewer home goods are required to buy the same amount of foreign goods, then we say that foreign currency has experienced a:

A) nominal appreciation.
B) nominal depreciation.
C) real appreciation.
D) real depreciation.

Question 39

If a real exchange rate appreciation occurs, which of the following results?

A) It takes more home goods to purchase the same quantity of foreign goods.
B) It takes fewer home goods to purchase the same quantity of foreign goods.
C) The nominal exchange rate has risen as well.
D) The nominal exchange rate has fallen.

Question 40

When the Chinese yuan is appreciating against the U.S. dollar, if relative PPP holds, then this suggests that the U.S. inflation rate:

A) exceeds the Chinese inflation rate.
B) equals the Chinese inflation rate.
C) exceeds the Chinese interest rate.
D) equals the Chinese interest rate.

Question 41

When the law of one price holds for all goods and services, the real exchange rate is always equal to:

A) one.
B) the nominal exchange rate.
C) relative prices across countries.
D) 1/nominal exchange rate.

Question 42

What is the Big Mac Index?

A) It is a price index for the top 20 stocks traded internationally.
B) It reflects inflation trends through trade in laptop computers and international price competition.
C) It is an index of the price of McDonald's hamburgers quoted in one currency designed to measure whether absolute PPP holds for Big Macs.
D) It is a measure of unemployment in the service industries of poor nations where Western retailers such as McDonalds have infiltrated.

Question 43

Globalization trends may ____ the tendency for prices to converge.

A) retard
B) speed up
C) eliminate
D) render irrelevant

Question 44

How could conditions of imperfect competition explain deviations from PPP?

A) Imperfect competition means that prices are higher than costs and may not converge.
B) Governments often restrict trade in those goods.
C) Goods sold under conditions of imperfect competition are often inferior.
D) Arbitrageurs do not recognize profit opportunities in these markets.

Question 45

The data on exchange rate and price-level fluctuations in the United States and the United Kingdom from 1975 to 2010 suggest that:

A) absolute and relative PPP hold in the long run.
B) absolute and relative PPP hold in the short run.
C) absolute and relative PPP do not hold in the long run.
D) It is impossible to determine the relationship between inflation and exchange rates between the two nations.

Question 46

(Table: Exchange Rates and Prices) Suppose a computer costs $500 in the United States. If PPP were to hold at the given nominal exchange rate, then the price of a computer in South Africa would be _____ rands.

A) 4,000
B) 40
C) 800
D) 8,000

Question 47

(Table: Exchange Rates and Prices) Suppose a computer costs $500 in the United States. With the price of the computer given in local currency, the Indian rupee is:

A) overvalued by 9.1%.
B) overvalued by 20%.
C) undervalued by 12.5%.
D) undervalued by 20%.

Question 48

Evidence suggests that convergence to PPP occurs:

A) instantly, as arbitrageurs take advantage of profit opportunities.
B) rapidly, as arbitrageurs learn of profit opportunities.
C) slowly, as arbitrageurs operate, and production, prices, and exchange rates adjust.
D) never.

Question 49

Short-run PPP may not hold for a variety of reasons. Which of the following is NOT cited in your textbook as one of those reasons?

A) weather and other environmental conditions that affect trade
B) transactions costs
C) nontraded goods
D) imperfect competition and price stickiness

Question 50

As economies adjust to inflation, there is an adjustment of exchange rates to reflect the changed price level. This adjustment is called:

A) real exchange rates.
B) convergence.
C) adjustment costs.
D) revaluation.

Question 51

(Table: Exchange Rates and Prices) Suppose a computer costs $500 in the United States. According to the information provided, under conditions of PPP, the price of a computer should be ____ reals in Brazil.

A) 2,200
B) 1,200
C) 1,100
D) 550

Question 52

Which of the following statements is NOT a reason for explaining the deviations from PPP?

A) Some goods are not tradeable.
B) Markets are imperfect and there could be legal obstacles.
C) Prices can be sticky in different countries.
D) There are no transportation costs.

Question 53

Economists have developed models to predict changes in exchange rates based on inflation trends. To guide forecasts of exchange rates, economists calculate the average:

A) speed of convergence.
B) PPP.
C) interest parity.
D) price deviation.

Question 54

(Table: Exchange Rates and Prices) Suppose a computer costs $500 in the United States. With the price of the computer given in the local currency, the South African rand is _______.

A) undervalued by 12.0%
B) overvalued by 3.0%
C) undervalued by 12.5%
D) undervalued by 1.25%

Question 55

The half-life of a PPP divergence indicates how long it takes:

A) to disappear.
B) for half of it to disappear.
C) to appear.
D) to reach half its greatest value.

Question 56

(Table: Exchange Rates and Prices) Suppose a computer costs $500 in the United States. With the price of the computer given in the local currency, the Brazilian real is _______.

A) undervalued by 22%.
B) undervalued by 12%.
C) overvalued by 9.1%.
D) overvalued by 20%.

Question 57

An example of a nontraded product would be:

A) corn.
B) haircuts.
C) shoes.
D) aircraft.

Question 58

(Table: Exchange Rates and Prices) Suppose a computer costs $500 in the United States. If PPP were to hold at the given nominal exchange rate, then the price of a computer in Mexico would be _____ pesos.

A) 500
B) 50
C) 5,000
D) 0.02

Question 59

The half-life of PPP deviations is about:

A) four months.
B) four quarters.
C) four years.
D) four decades.

Question 60

Price stickiness refers to:

A) slow movements in prices.
B) the sticker price for big-ticket items.
C) the price of oil.
D) the price of a Big Mac across countries.

Question 61

Better communication technology has made it easier to conduct ____ in international markets, thus ____ exchange rate adjustments to economic conditions and inflation.

A) open market operations; eliminating
B) arbitrage; speeding up
C) sales and purchases of currency; slowing down
D) portfolio investment; fundamentally changing

Question 62

Assume nominal GDP = PY, and = the proportion of nominal income that the nation holds (demands) as money to cover its transactions. Because nominal money supply equals nominal money demand, then:

A) increases in nominal income cause an increase in the money supply.
B) decreases in nominal income cause an increase in the money supply.
C) price increases cause an increase in the money supply.
D) an increase in the money supply causes a proportional increase in nominal income.

Question 63

The entity in any nation that accurately controls directly or indirectly the supply of money is referred to as the:

A) executive branch.
B) central bank.
C) treasury.
D) legislative branch.

Question 64

The MOST restrictive measurement of money is:

A) M0.
B) M1.
C) M2.
D) M3.

Question 65

According to the quantity theory of money, the demand for money is equal to:

A) nominal income divided by real income.
B) a constant proportion of nominal income.
C) the demand for money held as an asset.
D) real income divided by velocity.

Question 66

If money growth is bigger than income growth, then we can expect:

A) unemployment to increase.
B) inflation to decrease.
C) inflation to increase.
D) inflation and unemployment to decrease.

Question 67

Currency is a part of which measure of money?

A) M0 only
B) M1 only
C) M2 only
D) M0, M1, and M2

Question 68

If prices are held constant and income increases by 12%, the demand for money will:

A) decrease by 21%.
B) increase by 12%.
C) decrease by 12%.
D) Not enough information is provided to answer the question.

Question 69

Money's function as a medium of exchange is important because:

A) if there were no money, there would be no common unit of account.
B) if there were no money, society's wealth would be zero.
C) it eliminates the need for inefficient barter.
D) if there were no money, exchanges would be impossible.

Question 70

A nation with greater income, ceteris paribus, will have:

A) lower prices.
B) higher prices.
C) lower money supply.
D) higher prices and higher money supply.

Question 71

If nominal income in a nation decreases, economists would predict the:

A) supply of money will rise.
B) demand for money will rise.
C) supply of money will decrease.
D) demand for money will decrease.

Question 72

The price level in the country is determined by ______ and _______.

A) nominal money supply; demand for real money
B) demand for real money; average tax rate
C) demand for real money; growth of GDP
D) supply of real money; demand for real money

Question 73

The demand for real money balances is:

A) proportional to nominal income.
B) proportional to real income.
C) disproportional to real GDP.
D) determined by the real rate of interest.

Question 74

Money can be defined:

A) only as a unit of account.
B) only as a store of value.
C) only as a medium of exchange.
D) as a unit of account, a store of value, and a medium of exchange.

Question 75

The broad measure of money is referred to as:

A) M0.
B) M1.
C) M2.
D) M3.

Question 76

According to the long-run monetary model, we can rearrange terms in the money demand/supply in our long-run relationship to show that when the nominal supply of money is increased, ceteris paribus:

A) the demand for money is decreased.
B) the price level is increased.
C) real income is increased.
D) the price level is decreased.

Question 77

The M1 measure of money includes demand deposits but excludes:

A) currency in circulation.
B) Federal Reserve notes.
C) travelers' checks.
D) bank reserves.

Question 78

If we adjust the supply of money for changes in the price level, we get real balances. The demand for real balances is proportional to:

A) real GDP.
B) the unemployment rate.
C) the population.
D) the exchange rate.

Question 79

The criterion for including an asset in any measure of money is whether it is:

A) used for transactions and highly liquid.
B) used as a store of value.
C) used as collateral for loans.
D) stable and durable.

Question 80

In general, monetary economic theory states that the demand for money is proportional to:

A) nominal income.
B) the unemployment rate.
C) the population.
D) the exchange rate.