Deck 8: Purchasing Power Parity and Real Exchange Rates

Question 1

The version of purchasing power parity that states the exchange rates will adjust to equalize the internal and external purchasing power of a currency is known as the ________.

A) relative purchasing power parity
B) equilibrium purchasing power parity
C) absolute purchasing power parity
D) real exchange rate equilibrium

Answer 1

C

Question 2

When the price level of an economy is ________,________ is occurring.Conversely,when the price level is ________,________ is occurring.

A) rising, deflation, falling, inflation
B) rising, inflation, falling, deflation
C) falling, inflation, rising, deflation
D) falling, deflation, rising, deflation

Answer 2

B

Question 3

In its absolute version,purchasing power parity states that price levels worldwide should be ________ when expressed in a common currency.

A) equal
B) roughly equal
C) different
D) opportunities for arbitrage

Answer 3

A

Question 4

What is the name of the expression that refers to the costs that a firm incurs in changing its prices?

A) fixed costs
B) variable costs
C) cost-base pricing
D) menu costs

Question 5

One important reason to study the purchasing power parity theory is because

A) investors should borrow in a foreign currency, when there is a forward discount.
B) when inflation rates differ across international borders, PPP provides a baseline forecast of future exchange rates.
C) forecasting exchange rates is difficult and PPP makes it easier.
D) it provides currency dealers with a way to identify arbitrage opportunities.

Question 6

What is the name given to the weighted average of the nominal prices of the goods and services consumed in the economy?

A) nominal price
B) monetary value
C) price level
D) consumption bundle

Question 7

When is a currency said to be overvalued?

A) when its internal purchasing power is greater than its external purchasing power
B) when its external purchasing power is greater than its internal purchasing power
C) when its external purchasing power is less than its internal purchasing power
D) when its internal purchasing power is equal than its external purchasing power

Question 8

Understanding the theory of purchasing power parity is important because deviations from PPP significantly affect the

A) operations of the central bank.
B) hedging activities of multinational firms.
C) profitability of multinational firms.
D) arbitrage opportunities in the banking markets.

Question 9

All of the following options are some of the factors that cause deviations from absolute PPP EXCEPT:

A) transaction costs.
B) non-traded goods.
C) balance of payments.
D) changes in relative prices.

Question 10

Within the United States,what is the name for the power of a dollar when it is used to purchase an amount of goods and services?

A) internal purchasing power
B) external purchasing power
C) absolute purchasing power parity
D) relative purchasing power parity

Question 11

All of the following options are reasons why the prices of goods and services deviate from the law of one price EXCEPT:

A) sticky prices.
B) speculation.
C) tariffs and quotas.
D) price index.

Question 12

Which one of the following reasons for violations of the Law of One Price is the most obvious?

A) tariffs on imports
B) banking rules
C) industrial policies
D) exchange rate controls

Question 13

The theory of relative purchasing power parity states that,between two nations,the ________.

A) inflation rates are unrelated
B) exchange rate differential reflects the inflation rate differential
C) inflation rate is smaller in weaker currencies
D) the interest rate is greater than the inflation rate during depreciations

Question 14

When the external purchasing power or a currency is greater than the internal purchasing power,the currency is said to be ________.

A) overvalued
B) undervalued
C) at parity
D) in arbitrage

Question 15

When people describe what they think an exchange rate value should be,they often use a benchmark model,known as ________.

A) purchasing power parity
B) interest rate parity
C) the Fisher effect
D) the International Fisher effect

Question 16

In the absence of pure competition,firms who segment markets may be able to charge different prices in different countries for the same good.This practice is known as ________.

A) mark to market
B) interest rate arbitrage
C) pricing to market
D) speculation

Question 17

What is the name of the ratio of a price level at one point in time to the price level in a designated base year?

A) bid-ask spread
B) reserve requirement
C) percent spread
D) price index

Question 18

When the price of one commodity is the same wherever in the world the good is being sold when denominated in a particular currency,it is said the Law of ________ prevails.

A) currency supply
B) currency demand
C) purchasing power parity
D) one price

Question 19

The following options are all important reasons to study the theory of PPP EXCEPT:

A) it provides a baseline forecast of future exchange rates that is usually considered whenever it is necessary to forecast future cash flows in different currencies.
B) deviations from PPP significantly affect the profitability of firms.
C) it is particularly useful in assessing cost-of-living differences across countries
D) the deviations from the theory are very small when it comes to the determination of exchange rates

Question 20

Within Germany,what is the name for the power of a U.S.dollar when it is used to purchase an amount of goods and services?

A) internal purchasing power
B) external purchasing power
C) absolute purchasing power parity
D) relative purchasing power parity

Question 21

What is likely to happen to the balance of trade when inflation is great in Mexico than in the U.S.but the peso is pegged to the dollar?

Question 22

What is the distinction between relative purchasing power parity and absolute purchasing power parity?

Question 23

Under what conditions could the law of one price be violated?

Question 24

Suppose annual inflation rates in the U.S.and Mexico are expected to be 6% and 80%,respectively,over the next several years.If the current spot rate for the Mexican peso is $.005,then the best estimate of the peso's spot value in 3 years is ________.

A) $.00276
B) $.01190
C) $.00321
D) $.00102

Question 25

A 150% return in Belarus is higher than a 15% dollar return in the U.S.

A) because arbitrage opportunities exist.
B) when the inflation controls are suspended in Belarus.
C) it depends on whether these are nominal or real returns.
D) regardless of nominal or real returns.

Question 26

Explain what is meant by the real exchange rate?

Question 27

Could fluctuations in the real exchange rate cause deviations from absolute purchasing power parity? Why?

Question 28

If a country's freely floating currency is undervalued in terms of purchasing power parity,its capital account is likely to be

A) in deficit or tending toward a deficit.
B) in surplus or tending toward a surplus.
C) subsidized by the International Monetary Fund.
D) a candidate for loans from the World Bank.

Question 29

What effects do deviations from the law of one price have on absolute purchasing power parity?

Question 30

If people expect that their future purchasing power will decline,what will happen to the exchange rate today?

Question 31

When the currency of a country is stronger in foreign exchange markets than its PPP exchange rate,the dollar value of the country's GDP per capita when measured by current exchange rates is ________.

A) smaller than when measured by PPP exchange rates
B) larger than when measured by PPP exchange rates
C) the same as when measured by PPP exchange rates
D) slightly the same as when measured by PPP exchange rates

Question 32

Because the real exchange is composed of three variables that can all move simultaneously,many combinations of changes lead to a real appreciation of the pound (in this case).Which one of the following options is NOT a basic movement?

A) a decrease in the pound prices of U.S. goods, not holding the dollar prices constant
B) a decrease in the dollar prices of U.S. goods, holding the exchange rate and the pound prices of goods constant
C) an increase in the pound prices of goods, holding the exchange rate and the dollar prices of goods constant
D) an increase in the nominal exchange rate ($/?), holding the dollar prices and pound prices of goods constant

Question 33

What is more appropriate to use when attempting to find information about the purchasing power of a currency?

A) the spot exchange rate
B) the forward rate
C) the price levels
D) the price indexes