Deck 7: Prices and Exchange Rates: Purchasing Power Parity

Question 1

________ tends to hold better.

A) Absolute PPP
B) Relative PPP
C) Covered Interest Rate Parity
D) Big Mac Index

Answer 1

Covered Interest Rate Parity

Question 2

Which of the following statements is the most accurate?

A) Absolute PPP does not imply relative PPP.
B) Relative PPP implies absolute PPP.
C) Absolute PPP implies relative PPP.
D) There is no relationship between absolute and relative PPP.

Answer 2

Absolute PPP implies relative PPP.

Question 3

Suppose Russia's inflation rate is 200% over one year but the inflation rate in Switzerland is only 2%.According to relative PPP,

A) the Russian ruble should depreciate against Swiss franc by 198 percent.
B) the Russian ruble should appreciate against Swiss franc by 198 percent.
C) the Russian ruble should depreciate against Swiss franc by 202 percent.
D) the Russian ruble should appreciate against Swiss franc by 202 percent.

Answer 3

the Russian ruble should depreciate against Swiss franc by 198 percent.

Question 4

If the price of a pair of shoes in the U.S.is $80,the price of the same pair of shoes in Germany is 120 euro,and the exchange rate is 1.5 euro/$,the euro:

A) is correctly valued according to PPP.
B) is overvalued relative to PPP.
C) is undervalued relative to PPP.
D) None of the above is correct.

Question 5

In the presence of purchasing-power parity,if one dollar exchanges for 2 British pounds and if a flat-screen TV costs $400 in the United States,then in Great Britain the flat-screen TV should cost:

A) 200 pounds
B) 400 pounds
C) 600 pounds
D) 800 pounds

Question 6

Suppose the exchange rate between the U.S.dollar and the British pound is initially 2.00 dollars per pound.According to relative purchasing-power parity,if the price of traded goods rises by 10 percent in the United States and remains constant in the U.K,the exchange rate will become:

A) 1.80 dollars per pound
B) 1.98 dollars per pound
C) 2.02 dollars per pound
D) 2.20 dollars per pound

Question 7

Suppose that the U.S.dollar price of a Big Mac is $3.57.The price of a Big Mac in China is 12.5 yuan.Suppose that the current exchange rate is 6.83 yuan per dollar.If absolute PPP holds,the PPP-implied exchange rate is _______ and yuan is ________.

A) 3.50 yuan per dollar; overvalued.
B) 3.50 yuan per dollar; undervalued.
C) 1.83 yuan per dollar; overvalued.
D) 1.83 yuan per dollar; undervalued.

Question 8

Relative PPP indicates that

A) The same goods are sold for the same price internationally.
B) The exchange rate between two countries is equal to the ratio of their price indexes.
C) The percentage change in the exchange rate is equal to the inflation differential between two countries.
D) The inflation differential between two countries is equal to the forward premium.

Question 9

Suppose the exchange rate between the U.S.dollar and the Japanese yen is initially 90 yen per dollar.According to relative purchasing-power parity,if the price of traded goods rises by 10 percent in the United States and remains constant in Japan,the exchange rate will become:

A) 72 yen per dollar
B) 81 yen per dollar
C) 99 yen per dollar
D) 108 yen per dollar

Question 10

If absolute PPP holds,then the real exchange rate must be equal to:

A) a constant
B) a positive number
C) one
D) All of the above

Question 11

Suppose that the U.S.dollar price of a Big Mac is $3.57.The price of a Big Mac in Norway is 25 kroner.Suppose that the current exchange rate is 5.00 krone per dollar.If absolute PPP holds,the PPP-implied exchange rate is _______ and krone is ________.

A) 5.00 krone per dollar; overvalued.
B) 5.00 krone per dollar; undervalued.
C) 7.00 krone per dollar; overvalued.
D) 7.00 krone per dollar; undervalued.

Question 12

The equivalence of the percentage change in the exchange rate to the inflation differential between countries is referred to as the:

A) Absolute PPP
B) Relative PPP
C) Interest rate parity
D) None of the above

Question 13

Assume that the U.S.has a 2 percent inflation rate while Sweden has a 7 percent inflation rate.According to relative PPP,the dollar would be expected to:

A) Appreciate by 3.5 percent against the Swedish krona.
B) Depreciate by 3.5 percent against the Swedish krona.
C) Appreciate by 5 percent against the Swedish krona.
D) Depreciate by 5 percent against the Swedish krona.

Question 14

Assume that the United States faces a 5 percent inflation rate while no zero inflation exists in Japan.According to the relative PPP,the dollar would be expected to:

A) appreciate by 5 percent against the yen
B) depreciate by 5 percent against the yen
C) remain at its existing exchange rate
D) None of the above is correct.

Question 15

If the nominal exchange rate in dollars per pound rises by 5%,the U.S.inflation is 2%,and the U.K.inflation is 0%,what is the percent change in the real exchange rate?

A) 7%
B) 5%
C) 3%
D) 2%

Question 16

A year ago the spot rate of U.S.dollars for Canadian dollars was $1/C$1.Since that time,the rate of inflation in the U.S.has been 4% greater than that in Canada.Based on the theory of Relative PPP,the current spot exchange rate of U.S.dollars for Canadian dollars should be approximately _________ per Canadian dollars.

A) $0.96
B) $1
C) $1.04
D) $4

Question 17

Assume that the United States faces a 5 percent inflation rate while the U.K has a 7 percent inflation rate.According to the relative PPP,the dollar would be expected to:

A) appreciate by 2 percent against the British pound
B) depreciate by 2 percent against the British pound
C) appreciate by 12 percent against the British pound
D) depreciate by 12 percent against the British pound

Question 18

Under Purchasing Power Parity,

A) S_$/£ = P_US/P_UK
B) S_$/£ = P_UK/P_US
C) S_$/£ = P_US + P_UK
D) S_$/£ = P_US - P_UK

Question 19

Empirical evidence shows that in the short run,purchasing power parity _____,and in the long run,purchasing power parity _____.

A) holds; does not hold
B) holds; holds
C) does not hold; holds
D) does not hold; does not hold

Question 20

We can expect deviations from absolute PPP because of:

A) different bundles of goods across countries
B) quotas and tariffs
C) transactions costs.
D) All of the above are correct

Question 21

Assume that the U.S.has an 8 percent inflation rate while Mexico has a 4 percent inflation rate.According to relative PPP,the dollar would be expected to:

A) Appreciate by 2 percent against the Mexican peso.
B) Depreciate by 2 percent against the Mexican peso.
C) Appreciate by 4 percent against the Mexican peso.
D) Depreciate by 4 percent against the Mexican peso.

Question 22

Purchasing power parity is used for short term analysis because it tends to fail in the long run.

Question 23

If a watch costs $50 in the U.S.and 100 Swiss francs in Switzerland and the exchange rate is 2.25 Swiss franc per dollar,then the dollar is:

A) Correctly valued according to PPP.
B) Undervalued relative to PPP.
C) Overvalued relative to PPP.
D) Not enough information to find answer.

Question 24

If a currency has appreciated ________ the price differential between two countries as implied by PPP,then a currency is ________.

A) The same as, undervalued
B) The same as, overvalued
C) More than, overvalued
D) Less than, overvalued

Question 25

The relationship between product price levels and exchange rates is explained by:

A) Currency boards.
B) Purchasing power parity.
C) Per capita income levels.
D) Interest rate parity.

Question 26

If a pair of sunglasses costs $80 in the U.S.and 80 pounds in the U.K.and the exchange rate is 1.70 pound per dollar,then the pound is

A) Correctly valued according to PPP.
B) Undervalued relative to PPP.
C) Overvalued relative to PPP.
D) None of the above.

Question 27

The Big Mac index is used as:

A) A way to set exchange rates in different currencies
B) A way to set interest rates in different regions
C) A record of different ingredients in hamburgers in different regions
D) A measure of different prices in different countries

Question 28

If prices in the U.K.are rising slower than prices in the U.S.then

A) The pound depreciates.
B) The exchange rate stays the same.
C) The dollar depreciates.
D) The dollar appreciates.

Question 29

In the presence of purchasing-power parity,if five pesos exchange for one dollar and a new smartphone sells for $100 in Dallas,then the identical smartphone in Mexico City should cost:

A) 20 Pesos
B) 80 Pesos
C) 250 Pesos
D) 500 Pesos

Question 30

If a currency has appreciated more than the price differential between two countries as implied by PPP,then a currency is overvalued.

Question 31

Which of the following are reasons by the absolute PPP would not hold?
I.Consumer preferences
II.Transaction costs
III.Local taxes
IV.Company discounts

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

Question 32

Purchasing power parity PPP explains the relationship between interest rates and product price changes.

Question 33

Absolute PPP can be seen as an extension of ________ by generalizing the price of a good to the countrywide level.

A) Relative PPP
B) Law of one price
C) Exchange rate equilibrium
D) Equilibrium currency

Question 34

In the presence of purchasing-power parity,if one dollar exchanges for one Euro and a new laptop sells for $750 in New York,then the identical laptop in Paris should cost:

A) 400 Euros
B) 600 Euros
C) 750 Euros
D) 1000 Euros

Question 35

The exchange rate that is actually observed in the foreign exchange market is called the real exchange rate.

Question 36

If a currency has appreciated ________ the price differential between two countries as implied by PPP,then a currency is ________.

A) The same as, undervalued
B) The same as, overvalued
C) Less than, overvalued
D) Less than, undervalued

Question 37

According to the law of one price,identical goods will have the same price in different markets when the prices are expressed in the same currency if:

A) Both currencies are fixed.
B) Both currencies are floating.
C) There are no transaction costs and trade barriers.
D) Trade barriers protect arbitrary price changes.

Question 38

The real exchange rate is equal to one when absolute PPP holds.

Question 39

The equivalence of the exchange rate to the ratio of price levels between two countries is referred to as the:

A) Absolute PPP
B) Relative PPP
C) Interest rate parity
D) None of the above

Question 40

If the absolute PPP suggest that the dollar to pound should be 1.88 and the actual exchange rate in London is 2.50 $/pound,then:

A) The British pound is overvalued.
B) The U.S. dollar is overvalued
C) The British pound is undervalued
D) Exchange rates and absolute PPP are unrelated.

Question 41

The law of one price states that identical goods will have the same price in different markets as long as trade barriers are in place.

Question 42

If a bicycle costs $200 in the U.S.and 50 Swedish kronor in Sweden and the exchange rate is 0.25 Swedish krona per dollar,then the Swedish krona is:

A) Correctly valued according to PPP.
B) Undervalued relative to PPP.
C) Overvalued relative to PPP.
D) Not enough information to find answer.

Question 43

If the inflation rates of two countries are both equal to the percentage change in the exchange rate,then absolute purchasing power parity holds.

Question 44

The purchasing power parity captures the connection between the goods market and foreign exchange market.

Question 45

High-inflation countries rarely see purchasing power parity hold over time because of relative price changes.

Question 46

If the absolute PPP suggest that the yen to U.S.dollar is 84.50 and the actual exchange rate in New York is 85.50 Yen/$,then:

A) The Japanese yen is overvalued.
B) The U.S. dollar is overvalued
C) The U.S. dollar is undervalued
D) Exchange rates and absolute PPP are unrelated.

Question 47

After adjusting for inflation differentials between two countries,the exchange rate is referred to as:

A) Predicted exchange rate
B) Real exchange rate
C) Nominal exchange rate
D) Inflation exchange rate

Question 48

Which of the following prices indices can be used in determining purchasing-power parity?

A) Producer price index
B) Consumer price index
C) GDP Deflator
D) All of the above

Question 49

Government restrictions are used to keep the purchasing power parity from deviating over time.