Question 1

Assume the initial dollar/pound exchange rate to be $2 per pound.If the U.S.inflation rate is 8 percent, and the U.K.inflation rate is 3 percent, then the exchange rate should move to $2.10 per pound according to the purchasing-power-parity theory.

Accepted Answer

According to the purchasing-power-parity theory, the exchange rate should adjust to reflect the difference in inflation rates between countries. If the U.S. inflation rate is higher than the U.K. inflation rate, then the U.S. dollar should depreciate relative to the pound. In this case, the exchange rate should move from $2 per pound to $2.10 per pound to reflect the difference in inflation rates.

Question 2

If it is widely expected that the British economy will experience more rapid inflation than the Australian economy, then the pound will depreciate against the dollar under a system of floating exchange rates.

Accepted Answer

If the British economy is expected to experience more rapid inflation, it would lead to a decrease in demand for pounds, causing its value to depreciate against other currencies, such as the dollar, under a floating exchange rate system.

Question 3

Changes in market expectations have their greatest impact on exchange-rate changes over the long run as opposed to the short run.

Accepted Answer

Changes in market expectations can have immediate effects on exchange rates in the short run due to speculation and rapid adjustments in investment flows, whereas long-run exchange rate changes are more influenced by fundamental economic factors such as inflation rates, interest rates, and economic growth.

Question 4

In the short run, exchange rates are primarily determined by investor expectations of returns on assets, such as government securities and bank accounts.

Accepted Answer

In the short run, exchange rates are primarily determined by investor expectations of returns on assets.

Question 5

Long-run determinants of exchange rate include labor productivity levels, inflation rates, consumer preferences for goods and services, and trade barriers.

Accepted Answer

These are all factors that affect the long-term trends in exchange rates.

Question 6

If Mexico applies tariffs to imports of manufactured goods, then Mexico's demand for foreign exchange will rise, and the peso will depreciate under a system of floating exchange rates.

Accepted Answer

Tariffs on imports reduce the demand for foreign goods, thereby decreasing the demand for foreign currencies to pay for those imports. This could lead to an appreciation of the peso under a floating exchange rate system, not a depreciation.

Question 7

Under floating exchange rates, relatively low domestic interest rates tend to promote the depreciation of a currency's exchange value, while relatively high domestic interest rates lead to currency appreciation.

Accepted Answer

This is known as the interest rate parity theory, which suggests that higher interest rates attract foreign investors, increasing demand for the currency and leading to appreciation, while lower interest rates discourage foreign investment and lead to depreciation.

Question 8

As the profitability of Japanese assets rises relative to the profitability of Australian assets, Australian residents will make additional investments in Japan; this results in an increased demand for yen and a depreciation of the dollar under a system of floating exchange rates.

Accepted Answer

When the profitability of Japanese assets increases relative to Australian assets, Australian investors are incentivized to invest more in Japan. This leads to an increased demand for yen (as Australians convert their dollars to yen to invest), which under a floating exchange rate system, causes the Australian dollar to depreciate relative to the yen.

Question 9

Suppose expansionary monetary policy in the United States leads to interest rates falling to 2 percent, while tight monetary policy in Switzerland leads to interest rates rising to 8 percent.With floating exchange rates, the dollar would appreciate against the franc.

Accepted Answer

With lower interest rates in the United States compared to Switzerland, investors would likely seek the higher returns available in Switzerland, leading to a depreciation of the dollar against the franc as demand for francs increases to invest in Swiss assets.

Question 10

According to the asset-markets approach, adjustments among financial assets are a key determinant of long-run movements in exchange rates.

Accepted Answer

The answer of According to the asset-markets approach, adjustments among...

Question 11

If consumer tastes in the United States change in favor of goods produced in France, then the demand for francs will increase, which causes an appreciation of the dollar against the franc under a floating exchange rate system.

Accepted Answer

If the demand for francs increases, then the value of the franc should increase and the dollar should depreciate. The appreciation of the dollar against the franc would only occur if there was a decrease in the demand for francs.

Question 12

According to the "Big Mac" index, if a Big Mac costs $2.28 in the United States and 25.75 krone in Denmark (equivalent to $4.25), then the Danish krone is an undervalued currency.

Accepted Answer

The question is asking about the Danish krone, but the given market diagram is for the Swiss franc. Therefore, the answer cannot be determined based on the information provided.

Question 13

The purchasing-power-parity theory is used to predict exchange-rate movements in the short run.

Accepted Answer

The purchasing-power-parity theory is used to predict exchange-rate movements in the long run, not the short run.

Question 14

If Japan realizes technological improvements in the production of automobiles, which lowers its production costs relative to foreign producers, Japanese exports will rise, and the yen's exchange value will appreciate under a system of floating exchange rates.

Accepted Answer

If Japanese exports rise, there will be an increase in demand for yen to pay for those exports, causing an appreciation of the yen's exchange value. This is consistent with the basic theory of floating exchange rates.

Question 15

Economies with relatively high growth rates in labor productivity tend to find their currencies' exchange values appreciating under a floating exchange-rate system.

Accepted Answer

This statement is true. When an economy experiences high growth rates in labor productivity, it is generally seen as a positive sign by international investors, leading to an increased demand for that currency on the foreign exchange market. This increased demand, in turn, leads to an appreciation in the currency's exchange value. Under a floating exchange-rate system, the exchange rate is determined by market forces, meaning that these shifts in demand and supply for a currency can result in significant fluctuations in its value relative to other currencies.

Question 16

According to the "Big Mac" index, if a Big Mac costs $2.28 in the United States and 48 baht in Thailand (equivalent to $1.91), then the baht is an undervalued currency.

Accepted Answer

The "Big Mac" index compares the price of a Big Mac in different countries to assess whether currencies are valued appropriately against the US dollar. If a Big Mac is cheaper in a country (in this case, Thailand) than in the US, it suggests that the local currency (the baht) is undervalued relative to the US dollar.

Question 17

According to the law of one price, identical goods should cost the same in all nations, assuming there are no shipping costs nor trade barriers.

Accepted Answer

The law of one price implies that identical goods should cost the same in all nations, assuming there are no shipping costs nor trade barriers. This is based on the principle of arbitrage and the assumption of perfect competition. However, in reality, there may be other factors that affect the price of goods in different countries, such as differences in taxes, regulations, market power, and consumer preferences.

Question 18

Assume the initial yen/dollar exchange rate to be 100 yen per dollar.If the U.S.inflation rate is 2 percent, and the Japanese inflation rate is 7 percent, then the exchange rate should move to 105 yen per dollar according to the purchasing-power-parity theory.

Accepted Answer

According to the purchasing-power-parity (PPP) theory, if the U.S. inflation rate is lower than the Japanese inflation rate, the value of the yen should decrease relative to the dollar. This means more yen would be needed to buy a dollar. Starting from 100 yen per dollar, with U.S. inflation at 2% and Japanese inflation at 7%, the yen should depreciate more than to 105 yen per dollar to maintain purchasing power parity.

Question 19

The purchasing- power-parity theory predicts that if the U.S.inflation rate exceeds the Japanese inflation rate by 4 percent, then the dollar's exchange value will appreciate by 4 percent against the yen.

Accepted Answer

The statement mentions the U.S. inflation rate and Japanese inflation rate, but the graph and title are related to the market for Swiss Francs. Therefore, the statement is not relevant to the given graph and cannot be determined from it.

Question 20

If the United States experiences an enormous wheat crop failure, then it will have to import more wheat, and the dollar's exchange value will depreciate under a system of floating exchange rates.

Accepted Answer

If the United States has to import more wheat, it will require more foreign currency to pay for those imports, leading to an increase in demand for foreign currency and a decrease in demand for dollars. This will result in a depreciation of the dollar's exchange value under a floating exchange rate system.

Quiz 12: Exchange Rate Determination