lOMoARcPSD|13447620

Test bank 16 tif

International Economics (Istanbul Teknik Üniversitesi)

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International Economics, 10e Global Edition (Krugman/Obstfeld/Melitz)

Chapter 16 Price Levels and the Exchange Rate in the Long Run

16.
1TheLa
w ofOnePr
ice

1.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
stheMOSTac
cur
ate
?Thel
aw ofonepr
ices
tat
es
A)

i
ncompe t
it
ivemarke
tsf
reeoft
rans
por
tat
ionc
ost
sandoffic
ialbar
rie
rtot
rade
,ide
nti
calgoodss
oldi
ndi
ffe
rentc
ount
rie
s
musts
ellf
ort hes
amepri
ce.
B)

i
ncompe t
it
ivemarke
tsf
reeoft
rans
port
ati
oncost
sandoffici
albar
rie
rst
otrade
,ide
nti
calgoodss
oldi
ndi
ffe
rentc
ount
rie
s
musts
ellf
orthesamepri
cewhenthei
rpri
cesar
ee xpr
ess
e dinter
msofthesamecurr
ency.
C)

i
nc ompeti
ti
vemarket
sfr
eeofoffic
ialbar
rie
rtot
rade
,ide
nti
calgoodsar
esol
datt
hes
amepr
icer
egar
dle
ssof
t
ranspor
tati
oncos
ts.
D)

i
dent
icalgoodssol
dindi
ffe
rentc
ount
rie
smus
tse
llf
ort
hes
amepr
icewhe
nthe
irpr
ice
sar
eexpr
ess
edi
nte
rmsoft
he
s
amec urre
nc y
.
E)

i
ncompe t
iti
vemar ke
tsf
reeoft
rans
port
ati
oncost
sandoffici
albar
rie
rtotr
ade,i
dent
icalgoodss
oldi
nthes
amec
ount
ry
musts
ellf
ort hesamepri
cewhenthei
rpri
cesar
ee xpr
ess
e dinter
msofthesamecurr
e ncy.
Ans we
r:

B
Pa
geRe f
:445-447
Di
ffic
ult
y:Easy

2.

Unde
rPur
chas
ingPowe
rPar
ity
A)

E$/E= PUS- PE.

B)

E$/E= PUS/PE.
C)

E$/E= PE/PES.
D)

E$/E= PUS+ PE.

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 lOMoARcPSD|13447620

E)

E$/P= PUS/PE.
Answer:

B
Pa
geRe f
:445-447
Di
ffic
ult
y:Easy

3.

Expl
aint
heLa
w ofOnePr
ice
.Gi
veane
xampl
e.
Ans
wer:

Thel
a w ofonepr
icest
ate
sthati
ncompeti
ti
vemar
ket
sfr
e eoftr
ans
por
tat
ionc
ostsandt
radebar
rie
rs,i
dent
icalgoodss
old
i
ndiffe
rentcount
rie
smus ts
ellf
ort
hesamepri
cewhenexpres
sedi
nter
msofthesamecurr
ency
.

=(
E$/£)× ( )f
orgoodi
.

E$/£= /
If
,forexample,thepri
ceofthesamesweat
erwascheape
rinLondont
haninNew Yor
k,U.S.i
mport
ersandBri
ti
sh
export
erswoul dhaveanincent
ivet
obuysweate
rsinLondonandshi
pthe
mt oNew Yor
k,pushi
ngtheLondonpri
ceup
andtheNe w Yor kpr
icedown,unti
lbot
hwe r
eequal.
Pa
geRe f
:445-447
Di
ffic
ult
y:Mode ra
te

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 lOMoARcPSD|13447620

4.

Fi
lli
nthef
oll
owi
ngt
abl
e,as
sumi
ngt
hel
aw ofonepr
icepr
evai
ls
.

Ans
wer
:

Pa
geRe f
:445-447
Di
ffic
ult
y:Mode ra
te

16.
2Pur
chas
ingPowe
rPar
ity

1.

Unde
rPur
chas
ingPowe
rPar
ity
A)

E$/E= PE/PES.
B)

E$/E= Pi
E/Pi
US.
C)

E$/E= Pi
US/Pi
E.
D)

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 lOMoARcPSD|13447620

E$/E= PUS/PE.
E)

E$/E= Pi
E+ Pi
US/Pi
E.
Answer
:

D
Pa
geRe f
:447-449
Di
ffic
ult
y:Easy

2.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
stheMOSTac
cur
ate
?
A)

Thel
aw ofonepr
iceappl
iesonl
ytot
hege
ner
alpr
icel
eve
l.
B)

Thel
aw ofonepr
iceappl
iest
othege
ner
alpr
icel
eve
lwhi
lePPPappl
iest
oindi
vidualc
ommodi
ti
es.
C)

PPPappl
iesonl
ytoi
ndi
vidualc
ommodi
ti
es.
D)

Thel
aw ofonepr
iceappl
iest
oindi
vidualc
ommodi
ti
eswhi
lePPPappl
iest
othege
ner
alpr
icel
eve
l.
E)

Thel
aw ofonepri
ceappl
iest
oindi
vidualc
ommodi
ti
eswhi
lePPPappl
iest
obot
hthege
ner
alpr
icel
eve
landt
oindi
vidual
commodit
ies
.
Ans we
r:

D
Pa
geRe f
:447-449
Di
ffic
ult
y:Easy

3.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
stheMOSTac
cur
ate
?
A)

I
fthela
w ofonepr i
cedoesnothol
dtrueforever
ycommodi
ty,PPPc
annotbet
rueasl
ongast
her
efe
renc
ebas
ket
sus
edt
o
r
eckondiffe
rentc
ountr
ies
'pric
elevel
sarethesame.
B)

I
fthel
aw ofonepr
icehol
dst
ruef
ore
ver
ycommodi
ty,PPPmus
thol
daut
oma
tic
all
y.
C)

I
fPPPhol
dst
rue
,the
nthel
aw ofonepr
icehol
dst
ruef
ore
ver
ycommodi
tyasl
ongast
her
efe
renc
ebas
ket
sus
edt
ore
ckon

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 lOMoARcPSD|13447620

di
ffe
rentc
ount
rie
s'pr
icel
eve
lsar
ethes
ame
.
D)

I
fPPPhol
dstr
ue,t
hent
hel
aw ofonepr
icemus
thol
dtr
ueaut
oma
tic
all
y.
E)

I
fthelaw ofonepricehol
dstrueforeve
rycommodi
ty,PPPmus
taut
oma
tic
all
yhol
dasl
ongast
her
efe
renc
ebas
ket
sus
ed
t
oreckondiffe
rentcountr
ies
'pri
celevel
sar
ethes
ame.
Ans wer
:

E
Pa
geRe f
:447-449
Di
ffic
ult
y:Easy

4.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
stheMOSTac
cur
ate
?
A)

Re
lat
ivePPPimpl
iesabs
olut
ePPP
.
B)

Abs
olut
ePPPdoe
snoti
mpl
yre
lat
ivePPP
.
C)

Abs
olut
ePPPi
sinve
rse
lyr
ela
tedt
ore
lat
ivePPP
.
D)

Abs
olut
ePPPi
mpl
iesr
ela
tivePPP
.
E)

The
rei
snoc
ausal
it
yre
lat
ionbe
twe
ent
het
wo.
Answer
:

D
Pa
geRe f
:447-449
Di
ffic
ult
y:Easy

5.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
stheMOSTac
cur
ate
?
A)

Rel
ati
vePPPisonl
yval
idwhe
nabs
olut
ePPPi
sval
id,pr
ovi
dingt
hef
act
orsc
aus
ingde
via
tionsf
rom r
ela
tivePPPar
emor
e
orl
essst
abl
eoverti
me.
B)

Abs
olut
ePPPma
ybeval
ide
venwhe
nre
lat
ivePPPi
snot
,pr
ovi
dedt
hef
act
orsc
aus
ingde
via
tionsf
rom r
ela
tivePPPar
e

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 lOMoARcPSD|13447620

mor
eorl
esss
tabl
eove
rti
me.
C)

Re
lati
vePPPmaybevali
de venwhenabs
olutePPPisnot
,pr
ovi
dedt
hef
act
orsc
aus
ingde
via
tionsf
rom abs
olut
ePPPar
e
moreorle
sss
tabl
eove
rdiffer
entc
ommodi t
iesspac
e.
D)

Re
lati
vePPPma ybevali
devenwhe
nabs
olut
ePPPi
snot
,pr
ovi
dedt
hef
act
orsc
aus
ingde
via
tionsf
rom abs
olut
ePPPar
e
moreorle
ssst
ableove
rtime.
E)

Re
lat
ivePPPi
snotval
idwhe
nabs
olut
ePPPi
snot
.
Answer
:

D
Pa
geRe f
:447-449
Di
ffic
ult
y:Easy

6.

Expl
ainPurchas
ingPowe
rPar
ity
.
Answer:

PPPs t
atest
hatthee xchangerat
ebe t
wee nt
wocountr
ies
'curr
enci
esequal
stherati
oofthecount
ries
'pr
icel
evels
.
Af al
linacurre
nc y'sdome st
icpurchas
ingpower(
i.
e.aninc
reas
einthedome s
ticpri
cele
vel)wi
llbeas
soci
ate
dwi t
ha
proporti
onalc
ur r
e ncyde pr
ecia
tioninthef
orei
gnexc
hangemarketandvicever
sa.
= PUS/PEwhe
rePi
sthepr
iceofar
efe
renc
ecommodi
tybas
ket
.

Rear
range:PUS= ×(PE)
Thus,PPPasse
rtst
hatal
lcount
rie
s'pr
icel
eve
lsar
eequalwhe
nme
asur
edi
nte
rmsoft
hes
amec
urr
enc
y.
Pa
geRe f
:447-449
Di
ffic
ult
y:Mode ra
te

7.

Di
scus
sthere
lat
ionshi
pbe
twe
enPPPandt
heLa
w ofOnePr
ice
.
Answer:

Thelaw ofonepriceappliestoindividualcommodi t
ieswhil
ePPPappliest
othege ne
ralpr
icel
evel
.
ProponentsofPPPar guethatitsvali
dityinthelongrundoesn'
trequi
rethela
w ofonepric
etoholdexact
ly.Whengoods
andservic
e st
empor ari
lybecomemor ee xpens
iveinonecountr
ythaninothers
,thedemandsforit
scurr
encyandit
s
product
sfalls
,pushingthee xchanger a
teanddome s
ticpr
ice
sbackinli
newithPPPandvi cever
sa.
Pa
geRe f
:447-449
Di
ffic
ult
y:Mode ra
te

8.

Di
scus
sthedi
ffe
renc
esbe
twe
enAbs
olut
ePPPandRe
lat
ivePPP
.

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 lOMoARcPSD|13447620

Ans
wer
:

Absol
utePPPs ta
test
ha tt
heexchangerat
ebetwe
entwocur
renc
iese
qualsther
ati
ooft
he i
rpri
cel
evel
s.Re l
ati
vePPPst
ate
s
t
hatthepe r
cent
agechangeint
hee xc
hangera
tebetwe
ent
woc ur
renc
iesove
ragivenpe
riodequal
sthediffe
rencebe
tween
t
heinfla
tionrat
esofthosetwocurrenc
ies
.
Pa
geRe f
:447-449
Di
ffic
ult
y:Mode ra
te

9.

Expl
ainwhyRel
ati
vePPPi
sus
efulwhe
ncompar
ingc
ount
rie
stha
tbas
ethe
irpr
icel
eve
lsondi
ffe
rentpr
oduc
tbas
ket
s.
Answer:

ForExample:I
ftheU.S.pric
elevelri
sesby10% overayearwhileEurope'
sris
e sbyonl y5%,re
lati
vePPPpredi
ctsa5%
depreci
ati
onofthedollara
gainsttheeuro.Thi
sjus
tcance
lsthe5% bywhi chU.S.infla
tione
xceedsEurope
an,l
eavingt
he
rel
ati
vedome s
ticandforei
gnpur c
hasingpowe r
sofbothcurre
nciesunchanged.
( - )
/ =( )US,t- ( ) tbe
E, tweendat
estandt- 1.
Rel
ati
vePPPisusef
ulwhencompari
ngc ountr
iest
hatbas
ethei
rpri
cele ve
lsondi
ffe
rentpr
oduc
tbas
ket
s.Re
lat
ivePPPma
y
beval
ideve
nwhe nabsol
utePPPi
snot.
Pa
geRe f
:447-449
Di
ffic
ult
y:Mode ra
te

10.

SupposeRussi
a'si
nfla
tionr
atei
s200% ove
roneye
arbutt
heinfla
tionr
atei
nSwi t
zerl
andisonl
y2%.Ac
cor
dingt
ore
lat
ive
PPP,whatshoul
dhappe novert
heyeartotheS
wis
sfr
anc'
sex
c hangera
teagai
nsttheRuss
ianrubl
e?
Answe r
:

(Eruble/franc,t- Er
ubl
e/f
ranc
,t-1)/Er
uble/fr
anc,t-1= 2- 0.
02= 1.
98
Sot herewi l
lbea198% deprec
iationoftherubleagains
tthefrancor
,conve
rse
ly,a198% appr
eci
ati
onoft
hef
ranca
gai
nst
ther uble
.
Pa
geRe f
:447-449
Di
ffic
ult
y:Mode ra
te

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 lOMoARcPSD|13447620

11.

As
sumi
ngr
ela
tivePPP
,fil
lint
het
abl
ebe
low:

Ans
wer
:

Us
ing( - )
/ = ΠUS,t- ΠE,tonege
ts:

Pa
geRe f
:447-449
Di
ffic
ult
y:Mode ra
te

3ALong-RunEx
16. changeRa
teMode
lBas
edonPPP

1.

I
norderf
ort
hec
ondi
tonE$/HK$= PUS/PHKt
i ohol
d,wha
tas
sumpt
ionsdoe
sthepr
inc
ipl
eofpur
chas
ingpowe
rpar
ity
make
?
A)

HKandt
heUSar
epe
rfe
ctl
ycompe
tit
iveandt
her
ear
enot
rans
por
tat
ionc
ost
sorr
est
ric
tionsont
rade
.
B)

Noar
bit
rageexi
sts
.
C)

Onl
ytha
tthe
rear
enot
rans
por
tat
ionc
ost
sandr
est
ric
tionsont
rade
.
D)

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 lOMoARcPSD|13447620

Onl
ytha
tthemar
ket
sar
epe
rfe
ctl
ycompe
tit
ive
,i.
e,P= MC.
.
E)

Thef
act
orsofpr
oduct
ionar
eide
nti
calbe
twe
enc
ount
rie
s.
Answer:

A
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

2.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
stheMOSTac
cur
ate
?
A)

I
nthelongrun,na
tionalpri
cel
eve
lspl
ayake
yrol
einde
ter
mini
ngbot
hint
ere
str
ate
sandt
her
ela
tivepr
ice
satwhi
ch
c
ountr
ies'
product
sar etr
aded.
B)

I
nthel
ongr
un,na
tionalpr
icel
eve
lspl
ayake
yrol
eonl
yinde
ter
mini
ngi
nte
res
tra
tes
.
C)

I
nthelongrun,na
tionalpri
cel
eve
lspl
ayami
norr
olei
nde
ter
mini
ngbot
hint
ere
str
ate
sandt
her
ela
tivepr
ice
satwhi
ch
c
ountr
ies'
product
sar etr
aded.
D)

Inthel
ongrun,nat
ionalpr
icel
eve
lspl
aynor
olei
nde
ter
mini
ngi
nte
res
tra
tesandt
her
ela
tivepr
ice
satwhi
chc
ount
rie
s'
produc
tsar
etrade
d.
E)

I
nthelongr
un,nat
ionalpr
icel
eve
lspl
ayake
yrol
eonl
yinde
ter
mini
ngt
her
ela
tivepr
ice
satwhi
chc
ount
rie
s'pr
oduc
tsar
e
t
rade
d.
Answer
:

A
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

3.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
stheMOSTac
cur
ate
?Inge
ner
al
A)

t
hemone
tar
yappr
oac
htot
hee
xchanger
atei
sbot
has
hor
tandl
ongr
unt
heor
y.
B)

t
hemone
tar
yappr
oac
htot
hee
xchanger
atene
ithe
rlongr
unnors
hor
trunt
heor
y.
C)

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 lOMoARcPSD|13447620

t
hemone
tar
yappr
oac
htot
hee
xchanger
atei
sal
ongr
unt
heor
y.
D)

t
hemone
tar
yappr
oac
htot
hee
xchanger
atei
scons
ide
redl
esspr
act
icalt
hant
hel
aw ofonepr
ice
.
E)

t
hemone
tar
yapproac
htot
hee
xchanger
atei
sas
hor
trunt
heor
y.
Answer
:

C
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

4.

Themone
tar
yappr
oac
hmake
sthege
ner
alpr
edi
cti
ont
hat
A)

t
heex
changerat
e,whichist
her e
lat
ivepri
ceofAmeri
canandEuropeanmoney
,isful
lyde
ter
mine
dint
hes
hor
trunand
l
ongr
unbyt herel
ati
vesuppli
esofthosemonie
sandthere
lat
ivedemandsf
orthem.
B)

t
heex c
hangerate
,whic
histherel
ati
vepri
ceofAme r
icanandEurope
anmone
y,i
sful
lyde
ter
mine
dint
hes
hor
trunbyt
he
r
ela
tivesuppl
iesoft
hosemonie
sandt her
ela
tivede
mandsf ort
hem.
C)

t
hemone
ysuppl
yint
heU.
S.wi
lladj
ustt
oEur
ope
anmone
tar
yequi
li
bri
um.
D)

t
heex c
hangerate
,whic
histherel
ati
vepri
ceofAme r
icanandEurope
anmone
y,i
sful
lyde
ter
mine
dint
hel
ongr
unbyt
he
r
ela
tivesuppli
esoft
hosemonie
sandt her
ela
tivede
mandsf ort
hem.
E)

t
heex c
hangerate
,whichist
herel
ati
vepr
iceofAme
ric
anandEur
ope
anmone
y,i
sful
lyde
ter
mine
dint
hel
ongr
unbyt
he
r
ela
tivesuppl
iesofthos
emonie
s.
Answe r
:

D
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

5.

Unde
rthemone
tar
yappr
oac
htoe
xchanger
atet
heor
y,mone
ysuppl
ygr
owt
hatac
ons
tantr
ate
A)

e
ventual
lyre
s ul
tsi
nongoingpri
celeveldefla
tionatt
hes amerate
,butchangesi
nthi ong-r
sl unde
fla
tionr
atedonota
ffe
ct
t
heful-e
l mploymentout
putleve
l,onlythelong-runrel
ativepr
icesofgoodsandse
rvic
es.

Downloaded by Hu?nh Anh Nguy?n ?oàn (nguyenhuynhanh231@gmail.com)

 lOMoARcPSD|13447620

B)

e
ventual
lyre
s ul
tsi
nongoingpri
cel
evelde
flat
iona
tthes amerat
e,butchange
sinthi
slong-r
unde
fla
tionr
atedonota
ffe
ct
t
heful-e
l mploymentout
putleve
lort
helong-runr
ela
tivepri
cesofgoodsands e
rvi
ces
.
C)

e
ventual
lyre
s ul
tsi
nongoingpri
cel
eveli
nfla
tiona
tthesamerat
e,butc
hangesi
nt hi
slong-r
uni
nfla
tionr
atedonota
ffe
ct
t
heful-e
l mploymentout
putleve
lort
helong-runrel
ati
vepr
ice
sofgoodsandservic
es.
D)

e
ventual
lyres
ult
sinongoi
ngpric
eleve
linfla
tionatt
hes amerat
e,butchange
sinthi
slong-r
uni
nfla
tionr
atedoa
ffe
ctt
he
f
ul-e
l mploymentout
putle
velandt ong-r
hel unr e
lat
ivepric
esofgoodsandservi
ces
.
E)

e
ventual
lyresul
tsi
nongoingpri
celevelinflat
ionatt
hesamerat
e,butchangesi
nthi
slong-r
uni
nfla
tionr
atedonota
ffe
ct
t
heful-e
l mploymentout
putleve
l,onlythel ong-r
unrel
ati
vepr
icesofgoodsandser
vic
es.
Answer:

C
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

6.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
stheMOSTac
cur
ate
?Inge
ner
al,unde
rthemone
tar
yappr
oac
htot
hee
xchanger
ate
A)

t
hei
nte
res
trat
eisnoti
nde
pende
ntoft
hemone
ysuppl
ygr
owt
hra
tei
nthel
ongr
un.
B)

t
hei
nte
res
tra
tei
snoti
nde
pende
ntoft
hemone
ysuppl
ygr
owt
hra
tei
nthes
hor
trun.
C)

t
hei
nte
res
tra
tei
snoti
nde
pende
ntoft
hemone
ysuppl
ygr
owt
hra
tei
nthel
ongr
un,buti
nde
pende
nti
nthes
hor
trun.
D)

t
hei
nte
res
trat
eisi
nde
pende
ntoft
hemone
ysuppl
ygr
owt
hra
tei
nthel
ongr
un.
E)

t
hei
nte
res
tra
tei
safac
toroft
hemone
ysuppl
ygr
owt
hra
teonl
yint
hes
hor
tte
rm.
Answer
:

A
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

7.

Downloaded by Hu?nh Anh Nguy?n ?oàn (nguyenhuynhanh231@gmail.com)

 lOMoARcPSD|13447620

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
stheMOSTac
cur
ate
?Inge
ner
al,unde
rthemone
tar
yappr
oac
htot
hee
xchanger
ate
A)

t
helong-r
unint
erestr
atedoesnotdepe
ndont heabs
ol el
ut e
veloft
hemone
ysuppl
y,andt
husc
ont
i nggr
nui owt
hint
he
moneysuppl
ywi l
lnotaffe
ctt
heinte
restr
ate
.
B)

whi
letheshor-r
t unint
eres
trat
edoesnotdependontheabs
ol el
ut e
veloft
hemone
ysuppl
y,c
ont
i ngde
nui cli
nei
nthe
moneysupplyevent
uall
ywi l
lnota
ffe
ctthei
nter
estr
ate
.
C)

whi
lethelong-r
uninte
restr
atedoe snotdepe
ndontheabs
ol el
ut e
veloft
hemone
ysuppl
y,c
ont
i nggr
nui owt
hint
he
moneysupplyevent
uall
ywi l
laffe
cttheint
eres
tra
te.
D)

whilet ong-r
hel uni nte
restrat
edoesde
pendont
heabs
ol el
ut e
veloft
hemone
ysuppl
y,c
ont
i nggr
nui owt
hint
hemone
y
supplydonotaffe
cttheinte
restr
ate
.
E)

whi
letheshor-r
t unint
eres
trat
edoe snotdependontheabs
ol el
ut e
veloft
hemone
ysuppl
y,c
ont
i nggr
nui owt
hint
he
moneysupplyevent
uall
ywi l
laffe
ctthei
nte
r e
stra
te.
Ans wer:

C
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

8.

Whoamongt hefol
lowi
ngl
is
tofpe
opl
eisane
arl
y20t
hce
ntur
yec
onomi
stf
rom Yal
eUni
ver
sit
ywhowr
ot hebookThe
et
The
oryo
fInt
eres
t?
A)

I
srae
lKi
rzne
r
B)

Gus
tavCas
sel
C)

PaulKr
ugman
D)

Da
vidRi
car
do
E)

I
rvi
ngFi
sher
Answe
r:

Downloaded by Hu?nh Anh Nguy?n ?oàn (nguyenhuynhanh231@gmail.com)

 lOMoARcPSD|13447620

Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

Downloaded by Hu?nh Anh Nguy?n ?oàn (nguyenhuynhanh231@gmail.com)

 lOMoARcPSD|13447620

9.

I
fpe
opl
eexpec
tre
lat
ivePPPt
ohol
d
A)

t
hediffe
rencebetweent
heinter
estr
atesoffe
redbydol
larandeurode
posit
swille
qualthedi
ffe
rencebet
wee
nthei
nfla
tion
r
ate
sexpe ct
ed,overt
herel
evanthor
izon,intheUni
tedStat
esandEurope
,res
pect
ive
ly,i
ntheshortrun.
B)

t
hedi ffe
rencebetweenthei
nter
estr
atesoffe
redbydol
larandeur
odeposi
tswi
llbebel
ow t
hediffe
renc
ebe
twe
ent
he
i
nfla
tionr a
tesexpec
ted,ove
rtherel
evanthoriz
on,i
ntheUnite
dStat
esandEur
ope,re
spec
tive
ly.
C)

t
hediffe
rencebet
weent
heint
eres
tra
tesoffe
redbydoll
arandeur
ode
pos
itswi
lle
qualt
hedi
ffe
renc
ebe
twe
ent
hei
nfla
tion
r
ate
sexpe ct
edinEur
opeandtheUnit
edStates
,re
spec
tive
ly.
D)

t
hedi ffe
rencebetweenthei
nter
estr
atesoffe
redbydol
larandeur
odeposi
tswi
llbeabovet
hediffe
renc
ebe
twe
ent
he
i
nfla
tionr a
tesexpec
ted,ove
rtherel
evanthoriz
on,i
ntheUnite
dStat
esandEur
ope,res
pect
ive
ly.
E)

t
hediffe
rencebet
weentheint
ere
str
ate
soffer
edbydollarande urodeposi
tswille
qualthedi
ffe
renc
ebe
twe
ent
hei
nfla
tion
r
ate
sexpe ct
ed,i
ntheUnit
edStat
esandEurope,r
espe
ctivel
y,overthere
levanthori
zon.
Answer:

E
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

10.

Unde
rPPP(
andbyt
heFi
she
rEffe
ct)
,al
lel
see
qual
A)

ari
seinacountry'
sexpe
cte
dinfla
tionr
atewi
lle
vent
ual
lyc
aus
eane
qualr
isei
nthei
nte
res
tra
tet
hatde
pos
itsofi
ts
cur
rencyoffe
r.
B)

af
alli
nacount
ry'
sexpe
ctedinfla
tionr
atewil
leve
ntual
lycaus
eaninversel
ypr
opor
tionalr
isei
nthei
nte
res
tra
tet
hat
de
posit
sofi
tsc
urre
ncyoffe
rtoac commodat
etheris
einexpec
tedi
nfla
tion.
C)

afal
linacountry'
sexpe
cte
dinfla
tionr
atewi
lle
vent
ual
lyc
aus
eane
qualr
isei
nthei
nte
res
tra
tet
hatde
pos
itsofi
ts
curr
encyoffe
r.
D)

ari
sei
nac ount
ry'
sexpec
tedinfla
tionr
atewil
leve
ntuall
ycauseal
essthanpropor
tionalr
isei
nthei
nte
res
tra
tet
hat
de
posi
tsofit
scurr
encyoffe
rtoaccommodatetheri
seinexpec
tedi
nfla
tion.
E)

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 lOMoARcPSD|13447620

ari
sei
nac ountry'
sexpec
tedinfla
tionrat
ewille
vent
ual
lycaus
eamore-thanpropor
tionalr
isei
nthei
nte
res
tra
tet
hat
de
posi
tsofit
sc urr
encyoffe
rinorde rt
oaccommodatef
ort
hehighe
rinfla
tion.
Ans wer:

A
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

11.

I
nthes
hor
trun
A)

t
hei
nte
res
trat
ene
verr
ise
swhe
nthedome
sti
cmone
ysuppl
yfal
ls
.
B)

t
hei
nte
res
tra
test
aysc
ons
tantwhe
nthedome
sti
cmone
ysuppl
yfal
ls
.
C)

t
hei
nte
res
tra
tecanr
isewhe
nthedome
sti
cmone
ysuppl
yfal
ls
.
D)

t
hei
nte
res
trat
eri
sesi
nthes
amepr
opor
tionast
hedome
sti
cmone
ysuppl
yfal
ls
.
E)

t
hei
nte
res
tra
tec
ande
cre
asewhe
nthedome
sti
cmone
ysuppl
yfal
ls
.
Answer
:

C
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

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 lOMoARcPSD|13447620

12.

Unde
rafle
xibl
e-pr
icemone
tar
yappr
oac
htot
hee
xchanger
ate
A)

whe
nthedomest
icmone
ysuppl
yfal
ls
,thepr
icel
eve
lwoul
dfal
lri
ghta
way
,ke
epi
ngt
hei
nte
res
tra
tec
ons
tant
.
B)

whe
nthedome
sti
cmone
ysuppl
yfal
ls
,thepr
icel
eve
lwoul
dfal
lri
ghta
way
,caus
ingar
educ
tioni
nthei
nte
res
tra
te.
C)

whe
nthedome
sti
cmone
ysuppl
yfal
ls
,thepr
icel
eve
lwoul
deve
ntual
lyf
all
,inc
reas
ingt
hei
nte
res
tra
te.
D)

whe
nthedomest
icmone
ysuppl
yfal
ls
,thepr
icel
eve
lwoul
dfal
lri
ghta
way
,caus
ingani
ncr
eas
eint
hei
nte
res
tra
te.
E)

whe
nthedomes
ticmone
ysuppl
yfal
ls
,thepr
icel
eve
lwoul
deve
ntual
lyf
all
,ke
epi
ngt
hei
nte
res
tra
tec
ons
tant
.
Answer:

A
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

13.

Unde
rst
ickypr
ice
s
A)

af
alli
nthemone
ysuppl
yke
epst
hei
nte
res
tra
tei
ntac
ttopr
ese
rvemone
ymar
kete
qui
li
bri
um.
B)

af
alli
nthemoneys
uppl
yrai
sest
hei
nte
res
tra
tet
opr
ese
rvemone
ymar
kete
qui
li
bri
um.
C)

af
alli
nthemoneys
uppl
yre
duc
est
hei
nte
res
tra
tet
opr
ese
rvemone
ymar
kete
qui
li
bri
um.
D)

af
alli
nthemone
ysuppl
yrai
sest
hei
nte
res
tra
tet
opr
ese
rvemone
ymar
kete
qui
li
bri
um i
nthel
ongr
un.
E)

af
alli
nthemone
ysuppl
ydoe
snotaffe
ctt
hei
nte
res
tra
tei
nthes
hor
trun,onl
yint
hel
ongr
un.
Answe
r:

B
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

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 lOMoARcPSD|13447620

14.

Unde
rst
ickypr
ice
s
A)

anint
eres
tra
ter
iseisass
oci
ate
dwi
thl
owe
rexpe
cte
dinfla
ti ong-r
onandal unc
urr
enc
yde
pre
cia
tion,s
othec
urr
enc
y
appre
cia
tesi
mme di
atel
y.
B)

anint
eres
tra
ter
iseisass
oci
ate
dwi
thl
owe
rexpe
cte
dde
fla
ti ong-r
onandal unc
urr
enc
yappr
eci
ati
on,s
othec
urr
enc
y
appre
cia
tesi
mme di
atel
y.
C)

anint
eres
tra
ter
iseisass
oci
ate
dwi
thl
owe
rexpe
cte
dinfla
ti ong-r
onandal unc
urr
enc
yde
pre
cia
tion,s
othec
urr
enc
y
depre
cia
tesi
mme di
atel
y.
D)

anint
eres
tra
ter
iseisass
oci
ate
dwi
thhi
ghe
rexpe
cte
dinfla
ti ong-r
onandal unc
urr
enc
yappr
eci
ati
on,s
othec
urr
enc
y
appre
cia
tesi
mme di
atel
y.
E)

anint
eres
trat
eri
seisass
oci
ate
dwi
thl
owe
rexpe
cte
dinfla
ti ong-r
onandal unc
urr
enc
yappr
eci
ati
on,s
othec
urr
enc
y
appre
cia
tesi
mme di
atel
y.
Answe
r:

E
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

15.

Unde
rthemone
tar
yappr
oac
htot
hee
xchanger
ate
A)

anint
ere
str
atei
ncr
eas
eisas
soc
iat
edwi
thhi
ghe
rexpe
cte
dinfla
tionandac
urr
enc
ytha
twi
llbes
tre
ngt
hene
donal
lfut
ure
dat
es.
B)

ani
nte
res
tra
tei
ncr
eas
eisas
soc
iat
edwi
thhi
ghe
rexpe
cte
dinfla
tionandac
urr
enc
ytha
twi
llbewe
ake
ronal
lfut
ureda
tes
.
C)

ani
nte
res
tra
tei
ncr
eas
eisas
soc
iat
edwi
thhi
ghe
rexpe
cte
dde
fla
tionandac
urr
enc
ytha
twi
llbewe
ake
ronal
lfut
ureda
tes
.
D)

anint
ere
str
atei
ncr
eas
eisas
soc
iat
edwi
thhi
ghe
rexpe
cte
dde
fla
tionandac
urr
enc
ytha
twi
llbes
tre
ngt
hene
donal
lfut
ure
dat
es.
E)

ani
nte
res
tra
tede
cre
asei
sas
soc
iat
edwi
thhi
ghe
rexpe
cte
dinfla
tionandac
urr
enc
ytha
twi
llbewe
ake
ronal
lfut
ureda
tes
.

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 lOMoARcPSD|13447620

Ans
wer
:

B
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

16.

Unde
rthemone
tar
yappr
oac
htot
hee
xchanger
ate
A)

ar
educ
tioni
nthemone
ysuppl
ywi
llc
aus
eimme
dia
tec
urr
enc
yde
pre
cia
tion.
B)

ar
isei
nthemone
ysuppl
ywi
llc
aus
ecur
renc
yde
pre
cia
tion.
C)

ar
isei
nthemone
ysuppl
ywi
llc
aus
eimme
dia
tec
urr
enc
yappr
eci
ati
on.
D)

ar
isei
nthemone
ysuppl
ywi
llc
aus
eimme
dia
tec
urr
enc
yde
pre
cia
tion.
E)

ar
isei
nthemone
ys uppl
ywi
llc
aus
ede
pre
cia
tion.
Ans
wer:

D
Pa
geRe f
:449-455
Di
ffic
ult
y:Easy

17.

Expl
ainwhye
x c
hanger
atemode
lbas
edonPPPi
sal
ongr
unt
heor
y.
Answer:

PPPtheoryisamonet
aryapproacht
otheexchanger
ate.I
tisalong-r
unthe
orybecaus
eitdoesnotal
low f
orpr
ice
ri
gidi
ti
es.Itas
sumest
hatpri
cescanadj
ustr
ightawaytomai nt
ainfulle
mployme
ntaswe l
lasPPP.
Pa
geRe f
:449-455
Di
ffic
ult
y:Mode ra
te

18.

Pr
ese
ntandexpl
aint
heFundame
ntalEqua
tionoft
heMone
tar
yAppr
oac
h.
Answer
:

As
sume = PUS/PEandt
hatdome
sti
cpr
icel
eve
lsde
pendondome
sti
cmone
yde
mandsands
uppl
ies
:

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 lOMoARcPSD|13447620

PUS= MUSS/L(
R$,YUS)

PE= MES/L( ,YE)

Ther
efor
e,t
heexc
hangerat
eisful
lydet
ermine
dinthelongrunbytherel
ati
vesuppl
iesoft
hosemonie
sandther el
ati
ve
re
aldemandsf
orthem.Shif
tsi
ninte
res
trat
esandoutputl
evel
saffe
ctt
heexchanger
ateonl
ythrought
hei
rinflue
nceon
moneydemand.
Pa
geRe f
:449-455
Di
ffic
ult
y:Mode ra
te

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 lOMoARcPSD|13447620

19.

Wha
tar
ethepre
dicti
onsf
ort
hel
ongr
une
qui
li
bri
um oft
heMone
tar
yAppr
oac
h?
Answer:

Mone
ysuppl
i :Gi
es vent
hee
qua
tions
,
= PUS/PE
PUS= MUSS/L(R$,YUS)

PE= MES/L( ,YE)

onec
ans
how t
hatani
ncr
eas
eint
heU.
S.moneys yMUSSc
uppl aus
esapr
opor
tionali
ncr
eas
eint
heU.
S.pr
icel
eve
lPUS,

whi chinturnc ausesapr oport

ionalinc r
eas ein .Thus ,anincreas
einU.S.moneysupplycause
sapr oport
i ong-
onall
runde preci
ationoft hedollaragai
ns tthee uroandvi c
eve r
s a
.
Interestr
ates:Ar iseintheinteres
tr at
eR$l owersU. S.mone yde mandL(R$,YUS)the
rebycausi
ngar i
seintheU.S.pri
ce
levelandapr opor t
ionaldepreciat
ionoft hedol l
ara gainstthee ur
o.
Out putlevel
s :Ar i
seinU. S.outputYUSr aisesrealU. S.mone ydemandleadingt
oafalli
nthelong-r
unU. S.pri
celeve
l
andanappr eciat
ionofthedol l
a ragainstthee uro.
Pa
geRe f
:449-455
Di
ffic
ult
y:Mode ra
te

20.

Di
scus
stheeffec
tsofongoi
ngi
nfla
tionbas
edont
hePPPt
heor
y.
Ans wer:

Othert
hingsequal
,moneysupplygrowtha taconst
antrat
ee ve
ntual l
yre
sult
sinongoingpri
cel
eveli
nfla
tionatthesame
ra
teasthemone ysuppl
ygrowth,butchangesinthi
slong-r
uni nfla
tionr
atedonotaffe
ctt
heful
l-e
mployme ntoutputle
vel
ort ong-r
hel unrel
ati
vepri
cesofgoodsands er
vices
.

Theinte
res
trate
,howeve
r,i
saffect
edbycont
inuinggr
owthinthemone ysupply(i
nfla
tion).Thisc
anbeshownby
combini
ngPPPwi tht
heint
ere
s tpari
tyc
ondit
ion.Tos
how i
tanalyt
ical
ly,r
ecal
ltha
tthec onditi
onofpar
itybe
twe
endol
lar
andeuroasse
tsis:

R$= +( - )
/
Andac
cor
dingt
ore
lat
ivePPP:
( - )/ = ΠUS,
t- ΠE,t
I
fpeopleexpectr
ela
tivePPPtohol d,thediffe
rencebetweeni
nterestr
ate
soffe
redbydollarandeur
odepos
itswi
lle
qual
t
hediffe
rencebet
we e
nt heexpe
c te
di nfla
tionrate
s,overther
elat
ivehori
zon,int
heU.S.andEurope.
Pa
geRe f
:449-455
Di
ffic
ult
y:Mode ra
te

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 lOMoARcPSD|13447620

21.

Desc
ribeandexpl
aint
herela
tions
hipbe
twe
ene
xpe
cte
dinfla
tionr
ate
sint
woc
ount
rie
sandt
hei
rint
ere
str
atedi
ffe
rent
ial
ac
cordingt
othePPPtheor
y.
Answer
:

Expect
e di
nflat
ioni
sgive
nbyt hefol
lowinge
quat
ion:
Πe= (Pe- P)/PwherePeistheexpect
edpri
cel
eveli
nac
ount
ryaye
arf
rom t
oda
y.
Ifr
ela
tivePPPisexpec
tedtoholdthen:

( - )
/ -
Combi
net
hee
xpe
cte
dve
rsi
onofre
lat
ivePPPwi
ththei
nte
res
tpar
ityc
ondi
ti
on:

R$= +( - )
/
Re
arr
ange
:

R$- = -
I
f,asPPPpredi
cts
,cur
rencyde pre
ciati
oni se
xpe
cte
dtooffs
eti
nte
rna
tionali
nfla
tiondi
ffe
renc
e,t
hei
nte
res
tra
tedi
ffe
renc
e
mustequalt
heexpect
edinfla
tiondiffe
renc e.
Pa
geRe f
:449-455
Di
ffic
ult
y:Diffic
ult

22.

Wha
tist
heFi
she
rEffe
ct?Pr
ovi
deane
xampl
e.
Answer
:

Allelseequal,ar i
seinac ount r
y'se xpecte
di nflati
onratewillevent ual
lycauseanequalriseintheinterestr
atethat
depos i
tsofitscurrencyoffer.Si
mi larly
,afallint heexpect
edi nfla
tionratewille
ventuall
yc auseafallintheintere
strat
e.
Ex:Ifthee xpecte
dU. S.infla
tionwe retori
sepe rmane ntl
yfrom Π t oΠ + ΔΠ,c urre
ntdollarinte
restratesR$woul d
eventuall
yc atchupt othehi gherinflati
on,risi
ngbyaval ueΔR$= ΔΠ i nac c
ordancewitht heMone taryAppr oachthati
n
thelongr unpur elymone taryde velopme ntsshoul dhavenoe ffectonane conomy'srel
ati
vepr i
cessincetherealrateof
ret
ur nondol larasset
swoul dremai nunc hange d.
Pa
geRe f
:449-455
Di
ffic
ult
y:Mode ra
te

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 lOMoARcPSD|13447620

23.

Toans werthef
oll
owingquest
ion,pl
eas
erefertot
hefigur
ebe
low.Conc
ent
rat
ingonl
yatt
hel
owe
rri
ghtquadr
ant
,di
scus
s
theeffec
tsofachangei
nU.S.expect
edi
nfla
tion.

Ans
wer
:

Lowe
rri
ghtquadr
ants
howst
hee
qui
li
bri
um i
ntheU.
S.Mone
yMar
ket
,whe
re

= /

Agivenint
eres
tra
teR1$corr
espondswi t
hagi venU.S.realmoneysupply, / .
Consi
deraris
eofΔΠ int
hefuturera
teofU. S.moneys upplygrowth(i
.e.aninc
reas
ei ntheexpec
tedra
teofinfla
tion)
.
TheKeyPoint
:Theris
einexpect
edfutureinfla
tiongenerat
esexpect
ati
onsofmor erapidcurre
ncydeprec
iat
ionint he
fut
ure
.
UnderPPPthedoll
arnow de
preci
ate
sa tarateofΠ + ΔΠ.I nt
eres
tpari
tyt he
ref
orerequire
sthedoll
arint
ere
str a
tetoris
e
where

= + ΔΠ.(
Poi
nt2i
nthefigur
e.)

Not:R$-
e = -
Thi
sre
lat
ionshowsac
hangei
ntheU.S.i
nte
res
tra
teduetoani
ncr
eas
eine
xpe
cte
dU.
S.i
nfla
tionha
snoe
ffe
ctont
hee
uro
i
nte
res
trat
e.

Ther
isei
nthei
nte
res
tra
tef
rom t
o c
rea
tesamome
ntar
yex
ces
ssuppl
yofr
ealU.
S.mone
ybal
anc
esa
tthe
pr
evai
li
ngpr
icel
eve
l .Howe
ver
,si
nceunde
rthi
s.
Monet
aryApproach,pri
cesareas
sumedt
obefle
xible
,pric
eswilli
mme di
ate
lyadj
ustf
rom t
o ,thuscausi
ngthe
f
oll
owi
ngtwoeffec
ts:One,Reduci
ngre
almone
ys upplyandtwo,bri
ngi
ngU.S.moneymarke
tbacki
ntoequi
li
bri
um.
Pa
geRe
f:449-455

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 lOMoARcPSD|13447620

Di
ffic
ult
y:Mode
rat
e

24.

Toanswerthefol
lowingques
tion,pleas
ere
fertothefigur
ebelow.Conce
ntr
ati
ngonl
yatthelowe
rle
ftquadr
ant
,di
scus
s
ther
elat
ionshi
pbe t
we e
ntheU.S.realmoneysupplyandt hedoll
ar/e
uroex
changer
ate
,E$/E.

Ans
wer
:

Thelowerlef
tquadr
antinthefiguredes
cri
bedthePurchas
ingPowerPar
ity(PPP)r
ela
tions
hip.Ther
ela
tions
hipbe
twe
en
theU.S.r
ealmoneysuppl
yandt hedol
lar
/euroexc
hangerate
,E$/Eisne
ga t
ive.

i
sequalt
othepr
icel
eve
lra
tio,PUS/ .

I
nthi
sde
riva
tionoft
her
ela
tions
hip,t
hef
oll
owi
ngvar
iabl
esar
eas
sume
dcons
tant
s: , ,and .

So, = /PUS

PUS↑ → ↑

→
Thus
,thepur
chas
ingpowe
rofdol
larde
cre
ase
sduet
othei
ncr
eas
eint
hepr
icel
eve
l.
→
i
.e
.,doll
arde
pre
cia
tesduet
oPPP
Pa
geRe f
:449-455
Di
ffic
ult
y:Mode ra
te

25.

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 lOMoARcPSD|13447620

Toanswert
hefol
lowi
ngques
tion,ple
aser
efe
rtot
hefigur
ebe
low.Conc
ent
rat
ingonl
yatt
heuppe
rri
ghtquadr
ant
,di
scus
s
thef
orei
gnexc
hangemar
ketequili
bri
um.

Ans
wer
:

Theupperr
ightquadr
antdescr
ibest
heequi
li
bri
um i
nthef
ore
igne
xchangemar
ket
.
WebeginwiththeI
nter
estPar
ityCondi
ti
on.

R$= +( - )
/
I
nge
ner
al,t
woe
ffe
ctsar
epr
ese
nt:

→ and →
Ari
seinthei
nter
e s
tra
tenormal
lycr
eat
esanexces
sdemandfordollarde
posit
sandappr
eci
ati
onint
hec
urr
encymarke
t.
However
,int
hiscaset
heinc
reas
eisduetohi
gherexpe
cte
dinfla
tionorhighe
rexpec
tedmonet
arygr
owt
hintheU.
S.

whichimpli
esafas
tere
xpec
tedde
pre
cia
tionoft
hedol
lara
gai
nstt
hee
uro,,t
hus
, goe
supandt
husr
educ
edt
he
at
trac
tive
nessofU.
S.depos
its
.
Pa
geRe f
:449-455
Di
ffic
ult
y:Mode ra
te

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 lOMoARcPSD|13447620

26.

I
sade
pre
cia
tionoft
hedol
lar
/eur
oex
changer
atec
orr
ela
tedwi
thade
cre
asei
nthedol
larr
etur
nonU.
S.de
pos
its
?
Answer:

No.
Ass
umet
hatt
heI
nte
res
tPar
ityi
smai
ntai
ned,i
.e
.,

R$= +( - )
/

Holdi
ng const
ant
,onewoul
de xpectadepr
eci
ati
onoft
hedollar
/eur
oexchangerat
e( i
.e
.incr
easein )t
obe
cor
rel
ate
dwi
thadec
reas
einR$,doll
arret
urnsoneurode
posi
ts.However
,thehighe
re xpect
edinfla
tioni
ntheU.
S.

i
mpl
iesani
ncr
eas
eint
he ,t
hee
xpe
cte
dfut
uredol
lart
oeur
oex
changer
ate
.Thus
,thequant
it
y( - )
/
goe
supand,i
ncr
eas
esde
spi
teade
pre
cia
tioni
nthec
urr
entdol
lart
oeur
oex
changer
ate
, .
Pa
geRe f
:449-455
Di
ffic
ult
y:Diffic
ult

27.

Doe
sthee
xis
te eofnon-t
nc radabl
egoodsal
low f
orde
via
tionsf
rom Pur
chas
ingpowe
rPar
ity?
Answer:

Yes,theexi
ste
nceofnontradabl
esall
owsdeviat
ionsfr
om PPP.Thisisbecausethepr
iceofanontrada
bleisdet
ermine
d
entir
elybyit
sdome st
icsupplyandde mandcurves
,andinturnfluctua
tionsindemandands upplyfort
hesegoodwill
affe
ctthepri
celeve
l.Examplesinc
ludehousi
ng,hairc
ut,s
ervi
cese t
c.
Pa
geRe f
:449-455
Di
ffic
ult
y:Mode ra
te

28.

Wha
teffe
ctdonon-t
radabl
egoodsha
veonPPP?
Answer
:

Thee ffe
ctisquitesubst
anti
al.
In2006,theout putofnon-tradabl
egoodsaccountedforabout46% ofU.S.GNP .
Alongwit
hhairc
ut ,non-t
s radablegoods
inc
luder outineme dic
altre
a tment
,housi
nge t
c.Forthemos tpar
t,non-t
radabl
egoodsarecompri
sedofservic
es,andthe
outputoft heconstruct
ionindustr
y.Non-tr
adablehelpexplai
nmuc hoft hewidedepar
tur
efrom PPPthati
spr e
sentin
empiricaldata.
Pa
geRe f
:449-455
Di
ffic
ult
y:Mode ra
te

29.

How c
anl
ongrunval
uesi
nther
eale
xchanger
atec
hange
?
Answer:

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 lOMoARcPSD|13447620

Aninc r
eas
einwor l
drelat
ivedemandf orU.S.outputc
ausesalong-runr
eala
ppre
cia
tio
nofthedol
lara
gainstt
hee ur
o(af
al
l
i
nre aldol
lar/eur
oe xc
hangerate)
.
Arelatvee
i xpansi
onofU.S.outputcausesalong-runr
ealdepr
eci
ati
onoft
hedoll
aragains
tthee
uro(ari
seinreal
dol
lar/euroe x
changerat
e).
Pa
geRe f
:449-455
Di
ffic
ult
y:Mode ra
te

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 lOMoARcPSD|13447620

30.

Des
cri
bethec hainofeventsleadingtoexc
hangeratedete
rmina
tionf
ort
hef
oll
owi
ngc
ase
s:
(
a) Aninc r
easeinU. S.mone ysuppl
y
(
d) I
ncr
e aseingrowt hrat
eofU. S.moneysupply
(
c) I
ncr
e aseinwor l
dr el
ativedemandforU.S.products
(
d) I
ncr
e aseinrel
ativeU.S.outputsuppl
y
Ans we r:

Chai
nofe
vent
sle
adi
ngt
oex
changer
atede
ter
mina
tion:
= ×( Pus /PE)
Increas
einU. S.moneys uppl y:Pusrisesinpr oport
iontot hemone ysupply;qr emainst
hesame.Alldoll
arpri
ceswi
ll
ri
se(incl
udingdolla
rpr iceofe ur
o).
Increas
eingr owthrat
eofU. S.mone ys upply:Infla
tionrate,dol
lari
ntere
strate,Pus,E,r
ise
sinproport
iontoPus.
Increas
einwor ldrel
ativedemandf orU. S.produc t
s:Ef al
ls,andqdoe saswe l
l.
Increas
einr e
lati
veU.S.out puts upply:Dol l
arde preci
ates
,lowersrel
ati
vepr i
ceof
U.S.output
,risei
nq,e ffe
ctonEi snotclearsinceqandPuswor kinoppos it
edi r
ect
ions.
Pa
geRe f
:449-455
Di
ffic
ult
y:Diffic
ult

31.

Const
ruc
tat ablet
hatwil
lsummar
izet
hee
ffe
ctsofmone
ymar
ketandout
putmar
ketc
hange
sont ong-r
hel unnomi
nal
dol
lar
/euroe xc
hangera
te
Answe r
:

Pa
geRe f
:449-455
Di
ffic
ult
y:Diffic
ult

16.
4Empi
ri
calEvi
denc
eonPPPandt
heLa
w ofOnePr
ice

1.

I
npr
act
ice
A)

c
hange
sinnat
ionalpr
icel
eve
lsr
ais
ethee
xchanger
ate
.
B)

c
hange
sinna
tionalpr
icel
eve
lsof
tent
ellusr
ela
tive
lyl
it
tl
eaboute
xchanger
atemove
ment
s.
C)

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 lOMoARcPSD|13447620

c
hange
sinna
tionalpr
icel
eve
lsl
owe
rthee
xchanger
ate
.
D)

c
hange
sinnat
ionalpr
icel
eve
lsof
tent
ellusaboute
xchanger
atemove
ment
s.
E)

c
hange
sinnat
ionalpr
icel
eve
lsma
tchi
dent
icalc
hange
sint
hee
xchanger
ate
.
Ans
we r:

B
Pa
geRe f
:455-456
Di
ffic
ult
y:Easy

2.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
stheMOSTac
cur
ate
?
A)

Thepr
ice
sofi
dent
icalc
ommodi
tybas
ket
s,whe
nconve
rte
dtoas
ingl
ecur
renc
y,di
ffe
rsubs
tant
ial
lyac
ros
scount
rie
s.
B)

Thepr
ice
sofide
nti
calc
ommodi
tybas
ket
s,whe
nconve
rte
dtoas
ingl
ecur
renc
y,ar
ethes
ameac
ros
scount
rie
s.
C)

Thepr
ice
sofi
dent
icalc
ommodi
tybas
ket
s,whe
nconve
rte
dtoas
ingl
ecur
renc
y,ar
eof
tent
hes
ameac
ros
scount
rie
s.
D)

Thepr i
cesofide
nti
calc
ommodi
tybas
ket
s,whe
nconve
rte
dtoas
ingl
ecur
renc
y,ar
ethes
ameac
ros
scount
rie
smor
ethan
50% oftheti
me .
E)

Thepric
esofi
denti
calc
ommodi
tybas
ket
s,whe
nconve
rte
dtoas
ingl
ecur
renc
y,donotdi
ffe
rsubs
tant
ial
lyac
ros
s
count
rie
s.
Ans
we r
:

A
Pa
geRe f
:455-456
Di
ffic
ult
y:Easy

3.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
stheMOSTac
cur
ate
?
A)

Thel
aw ofonepr
icedoe
snotf
arewe
lli
nre
cents
tudi
es.
B)

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 lOMoARcPSD|13447620

Thel
aw ofonepr
icedoe
sfar
ewe
lli
nmanyr
ece
nts
tudi
es.
C)

Thel
aw ofonepr
icedoe
sfar
ewe
lli
nal
lre
cents
tudi
es.
D)

Thel
aw ofonepr
icehasnotbe
ens
tudi
edr
ece
ntl
y.
E)

Thel
aw ofonepr
ices
ome
time
sfar
eswe
lli
nre
cents
tudi
es.
Answer:

A
Pa
geRe f
:455-456
Di
ffic
ult
y:Easy

4.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
stheMOSTac
cur
ate
?
A)

Re
lat
ivePPPiss
ome
time
sar
eas
onabl
eappr
oxi
mat
iont
otheda
tabutof
tenpe
rfor
mspoor
ly.
B)

Re
lat
ivePPPi
snotar
eas
onabl
eappr
oxi
mat
iont
otheda
ta.
C)

Re
lat
ivePPPi
ssome
time
sar
eas
onabl
eappr
oxi
mat
iont
otheda
ta.
D)

PPPi
ssome
timesar
eas
onabl
eappr
oxi
mat
iont
otheda
tabutus
ual
lype
rfor
mspoor
ly.
E)

PPPi
ssomet
imesare
asonabl
eappr
oxi
mat
iont
otheda
ta.
Answer
:

A
Pa
geRe f
:455-456
Di
ffic
ult
y:Easy

5.

Wha
tcane
xpl
ainthef
ail
ureofr
ela
tivePPPt
ohol
dinr
eal
it
y?
Ans
we r
:

Gove
rnme ntmeasure
soft hepri
cel
eveldiffe
rfrom c
ount
rytocount
ry.
Onereas
onf ort
hesediffe
renc
esist
hatpeopl el
ivi
ngindi
ffe
rentc
ountr
iess
pendt
hei
rinc
omei
ndi
ffe
rentwa
ys.

Downloaded by Hu?nh Anh Nguy?n ?oàn (nguyenhuynhanh231@gmail.com)

 lOMoARcPSD|13447620

Be causeofthisi nherentdiffer
enc eamongc ountri
es,cer
tainbas ketswillbeaffec
tedmor ebypr i
cec hange
sgi venthe ir
cons umptionsbas ket
.Fore xampl e,c
ons umersi
nc ountry
,X,e atsmor efishrela
tivetoanot
herc ountry.Moret hanlikely,
thegove rnme nt,uponde t
er miningac ommodi t
ybas kettoreflectpref
erence,willhaveanoverwhe lmingrepr es
entationof
fishintheirbas ket.Anypr icelevelchangeinthefishmar ketwi l
lbefeltpartic
ularlybycountr
yX, andtheirove r
allpr i
ce
levelwi l
lrefle
ctt his
.Thus,c hange si
nt herel
ati
vepr i
cesofbas ketcompone ntscanc aus
erela
tivePPPt obec omedi storte
d.
Pa
geRe f
:455-456
Di
ffic
ult
y:Mode ra
te

16.
5Expl
aini
ngt
hePr
obl
emswi
thPPP

1.

Whi
choft
hefol
lowi
ngar
ethe
ori
esme
antt
oexpl
ain"
WhyPr
iceLe
vel
sar
eLowe
rinPoor
erCount
rie
s"?
A)

onl
yBal
asa-Samue
s lson
B)

onl
yGol
dbe
rg-Kne
tte
r
C)

onl
yBha
gwa
ti-Kr
avi
s-Li
pse
y
D)

Bha
gwa
ti-Kr
avi
s-Li
pse
yandGol
dbe
rg-Kne
tte
r
E)

Bha
gwa
ti-Kr
avi-Li
s ps
eyandBal
asa-Samue
s lson
Answer:

E
Pa
geRe f
:457-464
Di
ffic
ult
y:Easy

2.

I
nJanuar
y2013,t
hewor
ld'
sche
ape
stBi
gMac
swe
res
oldi
n
A)

Rus
sia
.
B)

t
heCze
chRe
publ
ic.
C)

Chi
na.
D)

Ma
lys
ia.

Downloaded by Hu?nh Anh Nguy?n ?oàn (nguyenhuynhanh231@gmail.com)

 lOMoARcPSD|13447620

E)

t
hePhi
li
ppine
s.
Answe
r:

D
Pa
geRe f
:457-464
Di
ffic
ult
y:Easy

3.

ThePPPt
heoryf
ail
sinr
eal
it
yforal
loft
hef
oll
owi
ngr
eas
onsEXCEPT
A)

t
hei
nfla
tiondat
are
por
tedi
ndi
ffe
rentc
ount
rie
sar
ebas
edondi
ffe
rentc
ommodi
tybas
ket
s.
B)

t
rans
por
tcos
ts.
C)

monopol
is
ticorol
igopol
is
ticpr
act
ice
singoodsmar
ket
s.
D)

r
est
ric
tionsont
rade
.
E)

i
nfla
tionr
ate
sareunr
ela
tedt
omone
ysuppl
ygr
owt
h.
Answer
:

E
Pa
geRe f
:457-464
Di
ffic
ult
y:Easy

4.

Whi
choneoft
hef
oll
owi
ngs
tat
eme
ntsi
stheMOSTa
ccur
ate
?
A)

Thepur
chasi
ngpowe
rofanygi
venc
ount
ry'
scur
renc
ywi
llf
alli
ncount
rie
swhe
ret
hepr
icsofnon-t
e radabl
egoods
re
maincons
tant
.
B)

Thepur
chas
ingpowe
rofanygi
venc
ount
ry'
scur
renc
ywi
llf
alli
ncount
rie
swhe
ret
hepr
icsofnon-t
e radabl
egoodsf
all
.
C)

Thepur
chas
ingpowe
rofanygi
venc
ount
ry'
scur
renc
ywi
llf
alli
ncount
rie
swhe
ret
hepr
icsofnon-t
e radabl
egoodsr
ise
.
D)

Downloaded by Hu?nh Anh Nguy?n ?oàn (nguyenhuynhanh231@gmail.com)

 lOMoARcPSD|13447620

Thepurchasi
ngpowe
rofanygi
venc
ount
ry'
scur
renc
ywi
llr
emai
ncons
tanti
ncount
rie
swhe
ret
hepr
icsofnon-t
e radabl
e
goodsr
ise.
E)

Thepur
chas
ingpowerofanygi
venc
ount
ry'
scur
renc
ywi
lli
ncr
eas
einc
ount
rie
swhe
ret
hepr
icsofnon-t
e radabl
egoods
ri
se.
Answer:

C
Pa
geRe f
:457-464
Di
ffic
ult
y:Easy

5.

Whi
choneoft
hef
oll
owi
ngs
tat
eme
ntsi
stheMOSTa
ccur
ate
?
A)

Re
lat
ivepr
icec
hange
scoul
dle
adt
oPPPvi
ola
tionse
veni
ftr
adewe
ref
reeandc
ost
les
s.
B)

Pr
icec
hange
scoul
dle
adt
oPPPvi
ola
tionse
veni
ftr
adewe
ref
reeandc
ost
les
s.
C)

Pr
icec
hange
scoul
dnotl
eadt
oPPPvi
ola
tionse
veni
ftr
adewe
ref
reeandc
ost
les
s.
D)

Re
lat
ivepr
icec
hange
scoul
dle
adt
oPPPvi
ola
tionsonl
yift
radewe
ref
reeandc
ost
les
s.
E)

Re
lat
ivepr
icec
hangesc
oul
dnotl
eadt
oPPPvi
ola
tionse
veni
ftr
adewe
ref
reeandc
ost
les
s.
Answer:

A
Pa
geRe f
:457-464
Di
ffic
ult
y:Easy

6.

Whi
choneoft
hef
oll
owi
ngs
tat
eme
ntsi
stheMOSTa
ccur
ate
?
A)

De
par
tur
esf
rom PPPma
yof
tenbegr
eat
eri
nthes
hor
trunt
hani
nthel
ongr
un.
B)

De
par
tur
esf
rom PPPar
eeve
ngr
eat
eri
nthel
ongr
unt
hani
nthel
ongr
un.
C)

I
tishar
dtot
ellwhe
the
rde
par
tur
esf
rom PPPar
egr
eat
eri
nthes
hor
trunt
hani
nthel
ongr
un.

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 lOMoARcPSD|13447620

D)

De
par
tur
esf
rom PPPar
esi
mil
ari
nbot
hthes
hor
trunandl
ongr
un.
E)

De
par
tur
esf
rom PPPar
eal
waysgr
eat
eri
nthes
hor
trunt
hani
nthel
ongr
un.
Answer:

A
Pa
geRe f
:457-464
Di
ffic
ult
y:Easy

7.

Fl
oat
inge
xchanger
ate
s
A)

s
yst
ema
tic
all
yleadt
omuc
hlar
gerandmor
efr
eque
nts
hor
t-r
unde
via
tionsf
rom t
her
ela
tivePPP
.
B)

s
yst
ema
tic
all
yle
adt
omuc
hsmal
lerandl
essf
reque
nts
hor
t-r
unde
via
tionsf
rom t
heabs
olut
ePPP
.
C)

s
yst
ema
tic
all
yle
adt
omuc
hsmal
lerandl
essf
reque
nts
hor
t-r
unde
via
tionsf
rom t
her
ela
tivePPP
.
D)

s
yst
ema
tic
all
yleadt
omuc
hlar
gerbutl
essf
reque
nts
hor
t-r
unde
via
tionsf
rom t
heabs
olut
ePPP
.
E)

s
yst
ema
tic
all
yle
adtomuc
hsmal
lerbutmor
efr
eque
nts
hor
t-r
unde
via
tionsf
rom t
her
ela
tivePPP
.
Answer:

A
Pa
geRe f
:457-464
Di
ffic
ult
y:Easy

8.

Expl
ainwhypri
celeve
lsar
elowe
rinpoor
erc
ount
rie
s.
Answer:

Onetheorye xpl ainsthedi fferencei npricesondi ffer

entendowme nt
sofc api
talandl abor(Bha gwait
,Kravi
s ,andLipsey)
.
Theexplanationi sasf ollows :
∙ Ric hc ount rie
sha vehi ghc apital-l
aborratioswhilepoorcountr
ieshavemuc hmor elaborr el
ati
vetoc api
tal
.
∙ Be caus eric hcount riesha vehi ghc apit
allaborrati
os,t
heMPLi sgr ea
terandt husthe yha veahigherwa ge.
∙ Hi ghe rwa gesleadt ohi gherdi s
pos abl
einc ome,andc i
ti
zens
'demandf orgoodswi llincreas
e.
∙ Be caus elabori sc he aperi npoorc ountr
iesandi susedint
ensi
velyinproduc ngnon-t
i radablegoods;non-tradabl
e
goodswillbec heape rint hepoorc ountr i
esthanint heric
h.

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 lOMoARcPSD|13447620

∙ Theprieofnon-t
c r
adabl
egoodswillmovewiththeinc
reaseinwage,
thusincr
eas
ingt
hepr
icel
eve
loft
hegood.
Ric
hCount
rie
s:Expe
nsiveNon-t
radabl
egoodsvs.PoorCountr
ies:CheapNon-t
radabl
egoods
.
Pa
geRe f
:457-464
Di
ffic
ult
y:Mode ra
te

16.
6Be
yondPur
chas
ingPowe
rPar
ity:AGe
ner lofLong-RunEx
alMode changeRa
tes

1.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
stheMOSTac
cur
ateaboutt
heLa
w ofOnePr
iceonSc
andi
navi
anf
err
yli
nes
?
A)

Toa
voi
dar
bitr
ageoppor
tuni
ti
es,t
heLa
w ofOnePr
icemus
thol
d.
B)

Tr
ans
act
ionc
ost
sofe
xchangi
ngc
urr
enc
ycaus
est
heLa
w ofOnePr
icet
ofai
l.
C)

Duet
ome
nucos
ts,t
heLa
w ofOnePr
icedoe
snothol
d.
D)

Tr
ans
por
tat
ioncos
tsbe
twe
enf
err
yli
nesl
eadst
oavi
ola
tionoft
heLa
w ofOnePr
ice
.
E)

Thephys
icaldi
stanc
eal
lowe
dtheLa
w ofOnePr
icet
ohol
d.
Ans wer:

B
Pa
geRe f
:464-472
Di
ffic
ult
y:Easy

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 lOMoARcPSD|13447620

2.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
sMOSTac
cur
ate
?
A)

TheUnite
dStat
espr
icele
velwi
llpl
acearel
ati
vel
yheavywe i
ghtonc
ommoditi
esproducedandcons
umedi
nEurope,and
theEur
opeanpri
cel
evelwil
lpl
acearel
ati
vel
yheavyweightoncommodi
ti
esproducedandcons
ume di
nAmer
ica.
B)

TheUnite
dStat
espr
icele
velwi
llpl
acearel
ati
vel
yli
ghtwei
ghtoncommoditi
esproducedandconsume
dinEurope,and
theEur
opeanpri
cel
evelwil
lpl
acearel
ati
vel
yheavywei
ghtoncommodit
iesproducedandconsumedi
nAme r
ica.
C)

TheUnite
dStat
espr
icele
velwi
llpl
acearel
ati
velyli
ghtwe i
ghtonc
ommoditi
esproducedandcons
umedinAme r
ica
,and
theEur
opeanpri
cel
evelwil
lpl
acearel
ati
vel
ylightweightoncommodi
ti
esproducedandcons
ume di
nEurope
.
D)

TheUni
tedSta
tespr
icel
eve
lwil
lplacear
elat
ivel
yhe
avyweightonc
ommodit
iespr
oducedandc
onsume
dinAmeri
ca,
andt
heEuropeanpri
cel
evelwi
llpl
acearel
ati
vel
yheavywe
ightoncommodi
ti
esproduc
edandcons
umedi
nEur
ope.
E)

TheUnit
edState
spric
elevelwi
llplac
earel
ati
velyl
ightwei
ghtoncommodi
ti
esproducedandcons
umedi
nAmeri
ca,
whil
etheEuropeanpri
cele
velwillpl
acear
elat
ivel
yhe a
vyweightonc
ommodit
iesproduc
edandcons
umedi
nEurope.
Answer:

D
Pa
geRe f
:464-472
Di
ffic
ult
y:Easy

3.

Whe
nthedomest
icmone
ypr
ice
sofgoodsar
ehe
ldc
ons
tant
A)

anomi
naldoll
arde
pre
cia
tionmake
sU.
S.goodsmor
eexpe
nsi
vec
ompar
edwi
thf
ore
igngoods
.
B)

anominaldoll
ardepr
eci
ati
onmakesU.
S.goodscheaperc
omparedwi
thf
ore
igngoodsandanomi
naldol
larappr
eci
ati
on
makesU.S.goodsmoree
xpens
ivec
omparedwithforei
gngoods
.
C)

anomi
naldoll
arappr
eci
ati
ondoe
snotaffe
ctt
hepr
ice
sofU.
S.goods
.
D)

anomi
naldoll
arappr
eci
ati
onmake
sU.
S.goodsc
hea
perc
ompar
edwi
thf
ore
igngoods
.
E)

anomi
naldol
lardepr
eci
ati
onmake
sU.
S.goodsl
essappe
ali
ngi
nfor
eignmar
ket
s.
Answer:

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 lOMoARcPSD|13447620

B
Pa
geRe f
:464-472
Di
ffic
ult
y:Easy

4.

Ani
ncr
eas
eint
hewor
ldr
ela
tivede
mandf
orU.
S.out
putc
aus
es
A)

ong-r
al unr
ealappr
eci
ati
onoft
hee
uroa
gai
nstt
hedol
lar
.
B)

ong-r
al unr
ealde
pre
cia
tionoft
hedol
lara
gai
nstt
hee
uro.
C)

ong-r
al unr
ealappr
eci
ati
onoft
hedol
lara
gai
nstt
hee
uro.
D)

as
hor
t-r
unr
ealde
pre
cia
tionoft
hedol
lara
gai
nstt
hee
uro.
E)

as
hor
t-r
unrealappre
cia
tionoft
hee
uroa
gai
nstt
hedol
lar
.
Answer:

C
Pa
geRe f
:464-472
Di
ffic
ult
y:Easy

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 lOMoARcPSD|13447620

5.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
sMOSTac
cur
ate
?
A)

Arel
ati
vee
xpansionofU.S.out
putcaus
esal ong-r
unde pr
eci
ati
onoft
hedol
laragai
nstt
heeur
o,whi
lear
ela
tive
e
xpansi
onofEuropeanoutputcaus
esalong-runrealappr
eci
ati
onoft
hedol
lara
gainstt
hee
uro.
B)

Arel
ati
vee
xpansionofU.S.out
putcaus
esal ong-r
unapprec
iat
ionoft
hedol
laragai
nstt
heeur
o,whi
lear
ela
tive
e
xpansi
onofEuropeanoutputcaus
esalong-runrealde
pre
ciat
ionoft
hedol
lara
gainstt
hee
uro.
C)

Arel
ati
vedecl
ineofU.S.outputcaus
esalong-r
unde pre
c i
ati
onoft
hedoll
aragai
nstt
hee
uro,whi
lear
ela
tivee
xpans
ionof
Eur
opeanoutputcaus
esal ong-r
unrealappr
ecia
tionofthedoll
ara
gai
nsttheeur
o.
D)

Arel
ati
vedecl
ineofU.S.outputcaus
esalong-r
unde pre
c i
ati
onoft
hedoll
aragai
nstt
hee
uro,whi
lear
ela
tivede
cli
neof
Eur
opeanoutputcaus
esal ong-r
unrealappr
ecia
tionofthedoll
ara
gai
nsttheeur
o.
E)

Arel
ati
veexpansi
onofU.S.outputc
aus e ong-r
sal undepre
cia
tionoft
hedoll
aragai
nstt
hee
uro,whi
lear
ela
tivede
cli
neof
Eur
opeanoutputcaus
esalong-runrealappr
eci
ati
onoft
hedollara
gai
nstt
hee ur
o.
Ans wer
:

A
Pa
geRe f
:464-472
Di
ffic
ult
y:Easy

6.

Whenallvari
able
sstar
touta
tthe
i ong-r
rl une
qui
li
bri
um l
eve
ls,t
hemos
timpor
tantde
ter
mi ong-r
nantofl uns
wingsi
n
nomi
nalexchangera
tesis
A)

ac
hangei
nrel
ati
vei
nfla
tionr
ate
s.
B)

as
hif
tinr
ela
tivemone
ysuppl
ygr
owt
hra
tes
.
C)

ac
hangei
nrel
ati
veout
putde
mand.
D)

as
hif
tinr
ela
tivemone
ysuppl
yle
vel
s.
E)

ac
hangei
nre
lat
iveout
puts
uppl
y.
Answer:

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 lOMoARcPSD|13447620

A
Pa
geRe f
:464-472
Di
ffic
ult
y:Easy

7.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
sMOSTac
cur
ate
?
A)

Int
heoutputmarket
,aninc
reas
eint
hede
mandf
orEur
ope
anout
putl
eadst
oani
ncr
eas
eint ong-r
hel unnomi
nal
dol
lar
/euroex
changerat
e.
B)

I
ntheoutputmarke
t,ani
ncr
eas
einde
mandf
orU.
S.out
putl
eadst
oani
ncr
eas
eint ong-r
hel unnomi
naldol
lar
/eur
o
e
xchangera
te.
C)

I
ntheoutputmarket
,aninc
reas
eint
hede
mandf
orEur
ope
anout
putl
eadst
oani
ncr
eas
eint ong-r
hel unnomi
nal
e
uro/dol
larex
changerat
e.
D)

Int
heoutputmarket
,aninc
reas
eint
hede
mandf
orEur
ope
anout
putl
eadst
oade
cre
asei
nt ong-r
hel unnomi
nal
dol
lar
/euroex
changerat
e.
E)

I
ntheoutputmar
ket,ade
cre
asei
nde
mandf
orU.
S.out
putl
eadst
oade
cre
asei
nt ong-r
hel unnomi
naldol
lar
/eur
o
e
xchangera
te.
Answer:

A
Pa
geRe f
:464-472
Di
ffic
ult
y:Easy

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 lOMoARcPSD|13447620

8.

Whi
choft
hefol
lowi
ngs
tat
eme
ntsi
sMOSTac
cur
ate
?
A)

Int
hemoneymar ket
,aninc
reas
einU.
S.mone
ysuppl
yle
vell
eadst
oapr
opor
tionali
ncr
eas
eint ong-r
hel unnomi
nal
dol
lar
/eur
oe x
changerat
e.
B)

Int
hemoneymarket
,aninc
reas
einU.
S.mone
ysuppl
ygr
owt
hra
tel
eadst
oade
cre
asei
nt ong-r
hel unnomi
nal
dol
lar
/eur
oexc
hangerat
e.
C)

Int
hemoneymarket
,aninc
reas
einU.
S.mone
ysuppl
yle
vell
eadst
oapr
opor
tionalde
cre
asei
nt ong-r
hel unnomi
nal
dol
lar
/eur
oexc
hangerat
e.
D)

Int
hemone ymarket
,anincr
eas
einEur
ope
anmone
ysuppl
yle
vell
eadst
oapr
opor
tionali
ncr
eas
eint ong-r
hel un
nominaldol
lar
/eur
oe x
changer
ate
.
E)

Int
hemoneymarket
,aninc
reas
einEur
ope
anmone
ysuppl
ygr
owt
hle
adst
oani
ncr
eas
eint ong-r
hel unnomi
nal
dol
lar
/eur
oexc
hangerat
e.
Ans
we r
:

A
Pa
geRe f
:464-472
Di
ffic
ult
y:Easy

9.

I
nthel
ongr
un
A)

e
xchanger
atesobe
yre
lat
ivePPPwhe
nal
ldi
stur
banc
esoc
curi
ntheout
putmar
ket
s.
B)

e
xchanger
ate
sobe
yabs
olut
ePPPwhe
nal
ldi
stur
banc
esoc
curi
ntheout
putmar
ket
s.
C)

e
xchanger
ate
sobe
yabs
olut
ePPPwhe
nal
ldi
stur
banc
esar
emone
tar
yinna
tur
e.
D)

e
xchanger
atesar
eunl
ike
lyt
oobe
yre
lat
ivePPPwhe
nal
ldi
stur
banc
esar
emone
tar
yinna
tur
e.
E)

e
xchanger
ate
sar
eunl
ike
lyt
oobe
yre
lat
ivePPPwhe
nal
ldi
stur
banc
esoc
curi
ntheout
putmar
ket
s.
Answer
:

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 lOMoARcPSD|13447620

E
Pa
geRe f
:464-472
Di
ffic
ult
y:Easy

10.

Dis
cussthedi
ffe
rente
ffe
ctsont
hedome
sti
cint
ere
str
ate
swhe
npr
ice
sar
eas
sume
dfle
xibl
eandwhe
nthe
yar
eas
sume
dto
best
icky
.
Ans
we r:

Whe npr i
cesarefle
xible
,ade cr
easeinthedome st
icmoneysuppl
yhasnoe ffec
tont heint
eres
trate
,becaus
eoft he
imme diat
ede c
reaseinthepr i
celevel
.Howe ver,whenprice
sareas
sumedt obes t
icky,adecr
easeinthedome st
icmoney
supplywi l
lcausetheinter
estrat
et ori
se,be
c ausethes
tic
kydome s
ticpr
icelevell
eadstoane xce
ssdemandf orrealmone
y
balance
sa tt
heiniti
alinter
estrat
e.
Pa
geRe f
:464-472
Di
ffic
ult
y:Mode ra
te

11.
Wha
tarethepre
dicti
onsoft
hePPPt
heor
ywi
thr
egar
dst
other
eale
xchanger
ate
s?
Answer:

Ther ealex
c hangerat
ebetwe
entwocountri
esisabr oadsummar ymeasur
eoft
hepri
cesonecount
ry'
sgoodsandservi
ces
re
lati
vet otheother'
s.PPPpr
edi
ctst
hattherealexc
hanger ateneverper
manent
lyc
hanges,whi
chisdi
ffe
rentf
rom nominal
exchangeratesthatdeal
swit
hthere
lat
ivepriceoftwoc ur
renci
es.
Pa
geRe f
:464-472
Di
ffic
ult
y:Mode ra
te

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 lOMoARcPSD|13447620

12.

Wha
tist
her
eale
xchanger
atebe
twe
ent
hedol
lara
ndt
hee
uroe
qualt
o?
Answe
r:

Le
t
∙ Re
aldol
lar
/eur
oex
changer
ate=
∙ Nominalex
changerae=
t
∙ Pr
iceofanunchangi
ngbas
ke nUS= Pus
ti
∙ Pr
iceofanunchangi
ngbas
keti ope= PE
nEur
The
n,
=( × PE)/PUS
Aris
eintherealdoll
ar/e
uroexc
hangerat
eiscal
ledarealdeprec
iatonoft
i hedol
laragai
nstthee
uro,afal
linpur
chas
ing
powerofthedoll
ar.
Afal
lintherealdol
lar
/euroe
xchanger
ateisc
alle
dar ealappr
eciat
ionoft
hedoll
a ra
gainstt
heeuro,ar
iseinpur
chas
ing
powerofthedoll
ar.
Pa
geRe f
:464-472
Di
ffic
ult
y:Diffic
ult

13.

Di
scus
swhyt
heempi
ri
cals
uppor
tforPPPandt
hel
aw ofonepr
icei
swe
aki
nre
centda
ta.
Answe
r:

Thefailureoftheseproposi
tionsintherealworldisr
ela
tedtot r
adebarr i
ersandde par t
uresfrom freecompet
it
ion,f
act
ors
thatcanr es
ultinpri
ci
ngt omarketbyexporte
rs.I
nadditi
on,diffe
r e
ntdefini
tionsofpricelevel
si ndiffe
rentc
ountri
es
bedevilattemptst
otestPPPus ingthepriceinde
x e
sgovernmentspubli
s h.Forsomepr oducts
,includingmanys e
rvic
es,
int
ernationaltr
ansportcost
sares ost
eepthatthesepr
oduc t
sbe comenon-tradable(seepa ge425).
Pa
geRe f
:464-472
Di
ffic
ult
y:Mode ra
te

14.

De
finet
heconce
ptoft
her
eale
xchanger
ateande
xpl
ainhow i
tdi
ffe
rsf
rom t
henomi
nale
xchanger
ate
.
Answer:

I
ngeneral
,therealexchangeratebet
we e
ntwoc ount r
ies
'curre
nc i
esisthepric
eofthese
condcountry'
scommoditybas ke
t
(
inte
rmsoft hefir
stcountry'
scurre
ncy)rel
ati
vetot hepric
eoft hefir
stcountr
y'sc
ommoditybasket
.Forexampl
e,inthe
c
aseofU.S.andEur ope,t
her e
aldolla
r/eur
oe xchangerateist
hedol larval
ueofEurope
'spri
cel
e ve
ldivi
dedbytheU. S.

pr
icel
eve
l.Wec
ant
husde
not
ether
ealdol
lar
/eur
oex
changer
ate( )a
s:

=( × PE)
/PUS

where i
sthenomi
naldol
lar
/euroexchangerate
,PEi sEurope '
spricel
evel
,andPUSi stheU.S.pri
celevel
.Unlikethe
r
ealexchangerat
e,whic
histherel
ati
vepric
eoftwoo utputbas
k e
ts,thenominalexchanger at
eist
her e
lati
vepriceoftwo
c
urre
ncies
.Howe ver
,aswecanseefrom t
hee qua
tionabove,re
ale xchangerat
esarede fine
dinter
msofnomi nalexchange
r
ates
.

Downloaded by Hu?nh Anh Nguy?n ?oàn (nguyenhuynhanh231@gmail.com)

 lOMoARcPSD|13447620

Pa
geRe f
:464-472
Di
ffic
ult
y:Diffic
ult

16.
7Int
erna
tionalI
nte
res
tRa
teDi
ffe
renc
esandt
heRe
alEx
changeRa
te

1.

I
nte
res
tra
tedi
ffe
renc
esbe
twe
enc
ount
rie
sde
pendon
A)

ne
ithe
rdi
ffe
rence
sine
xpe
cte
dinfla
tion,norone
xpe
cte
dchange
sint
her
eale
xchanger
ate
.
B)

di
ffe
renc
esi
nexpe
cte
dinfla
tionandnot
hinge
lse
.
C)

di
ffe
renc
esi
nexpe
cte
dinfla
tion,butnotone
xpe
cte
dchange
sint
her
eale
xchanger
ate
.
D)

di
ffe
renc
esi
nexpe
cte
dinfla
tion,andone
xpe
cte
dchange
sint
her
eale
xchanger
ate
.
E)

di
ffe
renc
esinexpect
edc
hange
sint
her
eale
xchanger
ate
,butnotone
xpe
cte
dinfla
tion.
Ans
we r
:

D
Pa
geRe f
:472-473
Di
ffic
ult
y:Easy

2.

Thee
xpe
cte
drat
eofc
hangei
nthenomi
naldol
lar
/eur
oex
changer
atei
sbe
stde
scr
ibe
das
A)

t
hee
xpe
cte
dr a
teofc
hangei
nther
ealdol
lar
/eur
oex
changer
atepl
ust
heEur
ope
ane
xpe
cte
dinfla
tion.
B)

t
hee
xpe
cte
dr a
teofc
hangei
nther
ealdol
lar
/eur
oex
changer
atemi
nust
heU.
S.-Eur
opee
xpe
cte
dinfla
tiondi
ffe
renc
e.
C)

t
hee
xpe
cte
dr a
teofc
hangei
nther
ealdol
lar
/eur
oex
changer
atepl
ust
heU.
S.-Eur
oper
eali
nte
res
tra
tedi
ffe
renc
e.
D)

t
hee
xpe
cte
dr a
teofc
hangei
nther
ealdol
lar
/eur
oex
changer
atemi
nust
heU.
S.-Eur
oper
eali
nte
res
tra
tedi
ffe
renc
e.
E)

t
hee
xpe
cte
drateofchangei
nther
ealdol
lar
/eur
oex
changer
atepl
ust
heU.
S.-Eur
opee
xpe
cte
dinfla
tiondi
ffe
renc
e.
Ans
we r:

Downloaded by Hu?nh Anh Nguy?n ?oàn (nguyenhuynhanh231@gmail.com)

 lOMoARcPSD|13447620

E
Pa
geRe f
:472-473
Di
ffic
ult
y:Easy

16.
8Re
alI
nte
res
tPar
ity

1.

Thee
xpe
cte
dreali
nte
res
tra
te(
re)i
nte
rmsoft
henomi
nali
nte
res
tra
te(
R)andt
hee
xpe
cte
dinfla
tionr
at πe
e( )i
sgi
venby
A)

e= R2- πe
r .
B)

e= 2πe+ R2.
r
C)

e= πe+ R.
r
D)

e= πe+ R2.
r
E)

e= R- πe
r .
Ans
wer
:

E
Pa
geRe f
:473-474
Di
ffic
ult
y:Easy

2.

Thedi
ffe
renc
ebet
wee
nnomi
nalandr
eali
nte
res
tra
tesi
stha
t
A)

r
eali
nte
res
trat
esar
ethes
amei
neve
ryc
ount
ry,whi
lenomi
nali
nte
res
tra
tesar
edi
ffe
rentf
ore
ver
ycount
ry.
B)

nomi
nali
nte
res
tra
tesar
eme
asur
edi
nte
rmsofac
ount
ry'
sout
put
,whi
ler
eali
nte
res
tra
tesar
eme
asur
edi
nmone
tar
y
te
rms
.
C)

nomi
nali
nte
res
tra
tesc
anfluc
tua
te,whi
ler
eali
nte
res
tra
tesal
waysr
emai
nfix
ed.
D)

r
eali
nte
res
trat
esc
anfluc
tua
te,whi
lenomi
nali
nte
res
tra
tesal
waysr
emai
nfix
ed.
E)

nomi
nali
nte
res
tra
tesar
eme
asur
edi
nmone
tar
yte
rms
,whi
ler
eali
nte
res
tra
tesar
eme
asur
edi
nte
rmsofac
ount
ry'
s

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 lOMoARcPSD|13447620

out
put
.
Ans
wer
:

E
Pa
geRe f
:473-474
Di
ffic
ult
y:Easy

3.

Wha
tist
her
eali
nte
res
tra
tepar
ityc
ondi
ti
on?
Answe
r:

Thenominali
nter
estr
ate
sar
era
tesofr
etur
nme
asur
edi
nmone
tar
yte
rms
.Ther
eali
nte
res
tra
tesar
era
tesofr
etur
n
measur
edinrealt
erms.

Re
alI
nte
res
tPar
ityCondi
ti
on:( - )= ( - )
/
Pa
geRe f
:473-474
Di
ffic
ult
y:Mode ra
te

16.
9Appendixt
oChapt
er16:TheFi
she
rEffe
ct,t
heI
nte
res
tRa
te,andt
heEx
changeRa
teUnde
rtheFl
exi
ble-Pr
ice
Mone
taryApproac
h

1.

Themonet
aryappr oachtoi
nter
estr
atesassumesthatt
hepr i
cesofgoodsare________,whic
himpli
esthatacount
ry'
s
cur
renc
ywill________,whennominalint
erestr
ate
s________becauseof________expect
edfut
urei
nflat
ion.
A)

i
mmut
abl
e;de
pre
cia
te;i
ncr
eas
e;hi
ghe
r
B)

pe
rfe
ctl
yfle
xibl
e;appr
eci
ate
;inc
reas
e;hi
ghe
r
C)

abs
olut
elyi
nfle
xibl
e;de
pre
cia
te;de
cre
ase
;hi
ghe
r
D)

i
mmut
abl
e;appre
cia
te;de
cre
ase
;hi
ghe
r
E)

pe
rfe
ctl
yfle
xible
;depr
eci
ate
;inc
reas
e;hi
ghe
r
Ans wer:

E
Pa
geRe f
:480-482
Di
ffic
ult
y:Mode ra
te

Downloaded by Hu?nh Anh Nguy?n ?oàn (nguyenhuynhanh231@gmail.com)

 lOMoARcPSD|13447620

2.

Whe
nthenomi
naldol
lari
nte
res
tra
te________,mone
yde
mandwi
ll________,andt
hege
ner
alpr
icel
eve
lwi
ll________.
A)

i
ncr
eas
es;i
ncreas
e;de
cre
ase
B)

i
ncr
eas
es;i
ncre
ase
;inc
reas
e
C)

i
ncr
eas
es;de
c r
eas
e;i
ncr
eas
e
D)

de
cre
ase
s;i
ncr
eas
e;i
ncr
eas
e
E)

i
ncr
eas
es;de
creas
e;de
cre
ase
Answer:

C
Pa
geRe f
:480-482
Di
ffic
ult
y:Easy

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