Question 1

"The Big Mac index is The Economist's burger-based measure of whether currencies are over- or undervalued.... [E]xchange rates should eventually adjust to make the price of a basket of goods the same in each country. Our basket contains just one item: the Big Mac hamburger, which is pretty much the same around the world."
The Economist, July 28, 2012
Which principle is The Economist relying on when using the Big Mac to value exchange rates?
A) interest rate parity
B) market price parity
C) purchasing power parity
D) exchange rate parity

Accepted Answer

The Economist is relying on purchasing power parity, which states that exchange rates should adjust in order to make the price of a basket of goods the same in each country. The Big Mac is a commonly purchased item around the world and serves as an indicator of the relative prices of goods in different countries.

Question 2

Given the U.S. price level P, the foreign country price level P*, and the real exchange rate RER in foreign currency per U.S. dollar, the nominal exchange rate E would be given by
A) E = RER × (P/P*).
B) E = RER × (P*/P).
C) E = (P/P*) / RER.
D) E = P × (RER/P*).

Accepted Answer

The nominal exchange rate E is calculated as E = RER × (P*/P), where RER is the real exchange rate, P is the domestic price level, and P* is the foreign price level. This formula adjusts the real exchange rate by the ratio of the foreign price level to the domestic price level to get the nominal exchange rate.

Question 3

Suppose that the price of an identical sport-utility vehicle is $32,000 in U.S. dollars in the United States and $32,000 in Canadian dollars in Canada. Suppose in addition that the exchange rate between Canada and the United States is one Canadian dollar equals $0.75 U.S. dollar. Based on this information what will happen to the exchange rate between the United States and Canada?
A) The value of the U.S. dollar will fall as U.S. residents purchase SUVs in Canada.
B) The value of the Canadian dollar will fall as Canadians purchase SUVs in the United States.
C) The exchange rate will stay the same because purchasing power parity already holds.
D) The value of the Canadian dollar will fall because Canadian prices are lower than U.S. prices.

Accepted Answer

The value of the U.S. dollar will fall as U.S. residents purchase SUVs in Canada because the SUV is cheaper in Canada when converted to U.S. dollars ($32,000 CAD * $0.75 USD/CAD = $24,000 USD), leading to an increased demand for Canadian dollars to make purchases, thereby increasing the value of the Canadian dollar relative to the U.S. dollar.

Question 4

A decrease in the demand for U.S. exports ________ the demand for U.S. dollars and shifts the demand curve for U.S. dollars ________.
A) increases; rightward
B) decreases; rightward
C) decreases; leftward
D) increases; leftward

Accepted Answer

A decrease in the demand for U.S. exports means that fewer foreign buyers are buying U.S. products, which means that there will be fewer foreign currency payments coming into the U.S. As a result, there will be a decrease in demand for U.S. dollars, which shifts the demand curve for U.S. dollars to the left.

Question 5

Initially the nominal exchange rate between the South Korean won and the U.S. dollar is 950 won per dollar. If the nominal exchange rate increases to 1000 won per dollar and the U.S and Korean price levels do not change, the real exchange rate
A) is the same as before.
B) is greater than before.
C) is less than before.
D) More information is needed to answer the question.

Accepted Answer

The answer of Initially the nominal exchange rate between the...

Question 6

The nominal exchange rate is
A) the value of the U.S. dollar expressed in units of foreign currency per U.S. dollar.
B) the real exchange rate multiplied by the ratio of the U.S. price level to the foreign price level.
C) the relative price of U.S. produced goods to foreign produced goods.
D) a measure of the quantity of the nominal GDP of other countries that we get per unit of U.S. nominal GDP.

Accepted Answer

The nominal exchange rate is the value of one currency expressed in terms of another currency (e.g. the value of the U.S. dollar expressed in units of foreign currency per U.S. dollar). It does not take into account differences in price levels or relative prices between countries.

Question 7

Suppose that the price of an identical sport-utility vehicle is $32,000 in U.S. dollars in the United States and $32,000 in Canadian dollars in Canada. Suppose in addition that the exchange rate between Canada and the United States is one Canadian dollar equals $0.75 U.S. dollar. Does purchasing power parity hold for SUVs between the United States and Canada?
A) Yes, because SUVs have the same price in each local currency.
B) No, because SUVs are more expensive in Canada than the United States.
C) No, because SUVs are more expensive in the United States than in Canada.
D) Without knowing interest rates, we can't say.

Accepted Answer

The answer of Suppose that the price of an identical...

Question 8

If the nominal exchange rate rises and price levels stay constant, the real exchange rate will
A) rise.
B) fall.
C) stay constant.
D) could rise, fall or stay constant.

Accepted Answer

The real exchange rate is defined as the nominal exchange rate adjusted for differences in price levels between two countries. If price levels stay constant and the nominal exchange rate rises, then the real exchange rate will also rise. This means that the currency of the country whose nominal exchange rate has risen has become relatively more valuable compared to the other country's currency.

Question 9

Suppose that your firm wants to import sugarcane from Brazil. The exchange rate is 3 Brazilian reals per U.S. dollar and sugarcane costs 36 reals per ton. How much is a ton of sugarcane in U.S. dollars?
A) $12
B) $39
C) $108
D) $109

Accepted Answer

To convert the cost from reals to U.S. dollars, divide the local price by the exchange rate: 36 reals / 3 reals per dollar = $12.

Question 10

If the price level in the U.S. is 120, the price level in South Africa is 140, and the nominal exchange rate is 7 South African rands per dollar, then the real exchange rate is
A) 6 South African goods per U.S. good.
B) 8.4 South African goods per U.S. good.
C) 9.8 South African goods per U.S. good.
D) 1.4 South African goods per U.S. good.

Accepted Answer

The answer of If the price level in the U.S....

Question 11

In the long run, the nominal exchange rate
A) is a monetary phenomenon, determined by the quantities of money in two countries.
B) is not related to the real exchange rate, since the real exchange rate is the true value of currencies.
C) will not change if prices in one country change, since prices are nominal variables.
D) is fixed by world central banks, as indicated by the fixed exchange rate system.

Accepted Answer

The nominal exchange rate is determined by the supply and demand for currencies in the foreign exchange market, which is closely linked to the relative quantities of money in two countries. Therefore, A is the correct answer. B is incorrect because the real exchange rate takes into account changes in relative prices and is constructed using the nominal exchange rate and price levels in two countries. C is incorrect because changes in prices do affect the nominal exchange rate, as seen in the inflation differentials between two countries. D is incorrect because the world has moved away from fixed exchange rates, and most countries now operate with floating exchange rates.

Question 12

When a nation's currency depreciates, the country might
A) have an inflation rate that exceeds the inflation rate in nations with which it trades.
B) have an inflation rate below the inflation rate in nations with which it trades.
C) be responding to an increase in the demand for its currency.
D) be responding to a decrease in the domestic demand for foreign currencies.

Accepted Answer

When a nation's currency depreciates, imports become more expensive, leading to an increase in the prices of goods and services that are imported. This can result in inflation in the country exceeding the inflation rate in nations with which it trades.

Question 13

Suppose that $1 U.S. costs $1.50 Canadian. If in St. Louis a CD costs $10 U.S. and in Montreal it costs $15 Canadian, then ________.
A) purchasing power parity holds
B) Canadians will buy CDs in St. Louis
C) Americans will buy CDs in Montreal
D) Virgin Records will have an incentive to build more stores in North America

Accepted Answer

Purchasing power parity (PPP) holds when the purchasing power of two currencies is the same, meaning the same goods cost the same amount in both currencies after exchange rate adjustment. In this case, a CD costs $10 in the U.S. and $15 in Canada. Given the exchange rate ($1 US = $1.50 Canadian), a $10 US CD converts to $15 Canadian, making the cost equal in both countries after considering the exchange rate. This is an example of purchasing power parity.

Question 14

Given the U.S. price level P, the foreign country price level P*, and the nominal exchange rate E expressed in foreign currency per U.S. dollar, the real exchange rate RER is given by
A) RER = E × (P/P*).
B) RER = E × (P*/P).
C) RER = (P/P*) / E.
D) RER = P / (E/P*).

Accepted Answer

The formula for real exchange rate is RER = E × (P/P*), which is represented in choice A.

Question 15

If the price level rises in the United States but not in foreign nations and the current exchange rate does not change, the expected future exchange rate
A) rises.
B) falls.
C) stays the same.
D) You can't tell from the given information.

Accepted Answer

If the price level rises in the United States but not in foreign nations, then American goods become relatively more expensive compared to foreign goods. As a result, people in the United States will buy more foreign goods, and people in foreign countries will buy fewer American goods. This leads to a higher demand for foreign currency and a lower demand for American currency. Thus, the value of the US dollar falls.

Question 16

The real exchange rate is the
A) relative price of U.S. produced output relative to foreign-produced output.
B) price of foreign goods relative to the price of domestic goods.
C) trade-weighted index.
D) current account balance.

Accepted Answer

The answer of The real exchange rate is the
A) relative...

Question 17

According to purchasing power parity, a rise in inflation in the United States. relative to the rest of the world will lead to
A) a balance of payments surplus.
B) a balance of payments deficit.
C) an exchange rate appreciation.
D) an exchange rate depreciation.

Accepted Answer

According to purchasing power parity, a rise in inflation in the United States relative to the rest of the world means that the prices of goods and services in the US will increase faster than in other countries. This will lead to a decrease in the demand for US exports and an increase in the demand for imports, leading to a higher supply of dollars in the foreign exchange market. As a result, the exchange rate of the dollar will depreciate, making US exports relatively cheaper and imports more expensive.

Question 18

Suppose that U.S. inflation is 3 percent and Turkish inflation is 70 percent. The effect of this discrepancy on the foreign exchange market is that
A) the Turkish currency will depreciate.
B) the dollar will depreciate.
C) it is impossible for interest rate parity to hold.
D) the Turkish currency will appreciate.

Accepted Answer

The higher inflation rate in Turkey will reduce the purchasing power of the Turkish lira, causing its value to depreciate relative to the U.S. dollar. Therefore, option A is the best choice.

Question 19

The real exchange rate is
A) the relative price of U.S. produced goods to foreign produced goods.
B) the nominal exchange rate multiplied by the ratio of the foreign price level to the U.S. price level.
C) the money price of foreign produced goods relative to the money price of U.S. produced goods.
D) a measure of how much currency exchanges for a unit of another currency.

Accepted Answer

The answer of The real exchange rate is
A) the relative...

Question 20

According to purchasing power parity, the foreign exchange market will
A) undervalue the dollar if inflation in the United States is greater than it is elsewhere.
B) no longer demand dollars if the inflation rate in the United States exceeds that of other nations.
C) adjust the value of the exchange rate to reflect differing inflation rates between nations.
D) result in a flow of dollars out of the United States whenever its rate of inflation is below that of other nations.

Accepted Answer

According to purchasing power parity theory, the exchange rate between two currencies will adjust to reflect the difference in inflation rates between the two countries. For example, if the inflation rate in the United States is higher than it is in another country, the exchange rate should adjust so that the cost of goods in the two countries is roughly equal. As a result, choice C is the correct answer because it accurately reflects the implications of purchasing power parity for the foreign exchange market.

Quiz 9: The Exchange Rate and the Balance of Payments

Given the U.S. price level P, the foreign country price level P*, and the real exchange rate RER in foreign currency per U.S. dollar, the nominal exchange rate E would be given by

A decrease in the demand for U.S. exports the demand for U.S. dollars and shifts the demand curve for U.S. dollars .

Initially the nominal exchange rate between the South Korean won and the U.S. dollar is 950 won per dollar. If the nominal exchange rate increases to 1000 won per dollar and the U.S and Korean price levels do not change, the real exchange rate

The nominal exchange rate is

If the nominal exchange rate rises and price levels stay constant, the real exchange rate will

Suppose that your firm wants to import sugarcane from Brazil. The exchange rate is 3 Brazilian reals per U.S. dollar and sugarcane costs 36 reals per ton. How much is a ton of sugarcane in U.S. dollars?

If the price level in the U.S. is 120, the price level in South Africa is 140, and the nominal exchange rate is 7 South African rands per dollar, then the real exchange rate is

In the long run, the nominal exchange rate

When a nation's currency depreciates, the country might

Suppose that $1 U.S. costs $1.50 Canadian. If in St. Louis a CD costs $10 U.S. and in Montreal it costs $15 Canadian, then ________.

Given the U.S. price level P, the foreign country price level P*, and the nominal exchange rate E expressed in foreign currency per U.S. dollar, the real exchange rate RER is given by

If the price level rises in the United States but not in foreign nations and the current exchange rate does not change, the expected future exchange rate

The real exchange rate is the

According to purchasing power parity, a rise in inflation in the United States. relative to the rest of the world will lead to

Suppose that U.S. inflation is 3 percent and Turkish inflation is 70 percent. The effect of this discrepancy on the foreign exchange market is that

The real exchange rate is

According to purchasing power parity, the foreign exchange market will