Deck 19: Exchange Rate Determination I the Real Exchange Rate

Question 1

The next questions refer to the following.
The nation of North does 20% of its trade with East, 30% with West, and 50% with South. Suppose that, relative to a base year, North's currency appreciates 80% against East's currency, appreciates 40% against West's currency, and depreciates 10% against South's currency.
Assuming all else remains constant,on a bilateral basis

A) East's currency has appreciated about 25% against West's currency
B) East's currency has depreciated about 30% against West's currency
C) East's currency has depreciated about 50% against South's currency
D) West's currency has appreciated about 35% against South's currency
E) West's currency has depreciated about 55% against South's currency

Answer 1

East's currency has depreciated about 50% against South's currency

Question 2

The law of one price

A) outlaws price discrimination
B) refers to output produced by a monopolist
C) states that in the absence of a price floor, a market achieves an equilibrium price
D) indicates how the prices of many goods are aggregated into a single composite price index for measuring inflation
E) assumes that goods cost nothing to distribute

Answer 2

assumes that goods cost nothing to distribute

Question 3

Generalized to all goods and services,the law of one price becomes known as

A) the law of many prices
B) exchange rate pass-through
C) pricing to market
D) purchasing power parity
E) price level equilibration

Answer 3

purchasing power parity

Question 4

If an export firm is pricing to market,the firm benefits most from

A) high tariffs in the importing countries
B) a strong domestic currency in the exporting country
C) depreciation of the exporting country's currency
D) being in a competitive industry where the law of one price holds
E) high transport costs to distant markets

Question 5

The next questions refer to the following.
Suppose the nominal Canadian - US exchange rate is C$1 = US$0.65 (so that one Canadian dollar buys 65 US cents), and the Canadian price level is twice as high as the US price level.
The real value of US$1 in Canada is then

A) C$0.65
B) C$0.77
C) C$1.30
D) C$1.40
E) C$1.54

Question 6

Nominal bilateral exchange rates are published daily in newspapers. The Washington Post reported the following exchange rates for the US dollar ($) on June 16,2004.
The table shows,for example,that $1 = ¥109.34 at that time. Which of the following must also have been true on that date?

A) €1 = $0.822
B) €1 = ¥202.22
C) ¥1 = €133.02
D) £1 = €1.505
E) $1 = £1.8312

Question 7

Which of the following does not explain why the law of one price fails?

A) products have different standard sizes and features in different countries
B) transporting a good to a distant market raises its cost
C) goods imported across borders are often subject to tariffs
D) nominal exchange rates do not change as often as product prices
E) firms may set prices to be competitive in local markets regardless of production and distribution costs

Question 8

The next questions refer to the following.
The nation of North does 20% of its trade with East, 30% with West, and 50% with South. Suppose that, relative to a base year, North's currency appreciates 80% against East's currency, appreciates 40% against West's currency, and depreciates 10% against South's currency.
Then on a trade-weighted basis,North's currency has effectively

A) appreciated by 23%
B) appreciated by 33%
C) appreciated by 110%
D) depreciated by 5%
E) depreciated by 13%

Question 9

The next questions refer to the following.
The nation of North does 20% of its trade with East, 30% with West, and 50% with South. Suppose that, relative to a base year, North's currency appreciates 80% against East's currency, appreciates 40% against West's currency, and depreciates 10% against South's currency.
If the exchange rate is defined according to British custom,then the effective exchange rate for North is now

A) 77
B) 87
C) 95
D) 110
E) 123

Question 10

If the Canadian dollar depreciates nominally by 10% while Canada experiences 5% inflation and the US experiences 10% inflation,then in real terms,the Canadian dollar

A) appreciates about 10%
B) appreciates about 5%
C) depreciates about 5%
D) depreciates about 10%
E) depreciates about 15%

Question 11

Which of the following is true regardless of how the exchange rate is defined?

A) when a currency appreciates, that country's exports become less expensive to foreign buyers
B) when a currency appreciates, the bilateral exchange rate falls
C) when a currency depreciates, each unit buys less foreign currency
D) when one currency depreciates, all other currencies tend to depreciate at the same time
E) when the exchange rate rises, the domestic currency is appreciating

Question 12

Which of the following conditions leads to the greatest exchange rate pass-through?

A) pricing to market by exporters
B) a small open economy
C) fixed exchange rates
D) a wide assortment of import-competing domestic goods
E) "dollarization" and currency unions, in which different nations adopt the same currency

Question 13

The next questions refer to the following.
Suppose the nominal Canadian - US exchange rate is C$1 = US$0.65 (so that one Canadian dollar buys 65 US cents), and the Canadian price level is twice as high as the US price level.
The real value of C$1 in the US is then

A) US$0.65
B) US$0.77
C) US$1.30
D) US$1.40
E) US$1.54

Question 14

For most currencies,the nominal bilateral exchange rate is defined as

A) the amount of domestic currency needed to buy one dollar
B) the amount of domestic currency needed to buy 1 unit of foreign currency
C) the amount of foreign currency for which 1 unit of domestic currency can be sold
D) the domestic currency price of the pound sterling
E) the quantity of gold that can be purchased for one unit of domestic currency

Question 15

Suppose the same automobile is produced by a multinational firm in the US and Europe. The price of the car is $12,500 in the US or €25,000 in Europe,and there are no transport costs or tariffs. Then according to the law of one price,the value of the dollar in terms of the euro should be

A) ½
B) 1
C) 2
D) 2.5
E) 4

Question 16

If the US dollar appreciates 10% against the Japanese yen and at the same time depreciates 10% against the British pound sterling,then holding all else constant,in nominal terms

A) the yen-pound exchange rate remains approximately constant
B) the yen appreciates about ten percent against the pound sterling
C) the yen depreciates about twenty percent against the pound sterling
D) US goods become 10% less expensive in Japan
E) British exports become about 20% less expensive to the Japanese

Question 17

Suppose that on a Monday,the US - UK bilateral exchange rate is such that $5 = £2. By Friday,$6 = £3. Then

A) the pound has depreciated by 20% of its initial value
B) the dollar has appreciated by 20% of its initial value
C) the pound has appreciated by 30% of its initial value
D) the pound has depreciated by 25% of its initial value
E) neither currency has appreciated or depreciated

Question 18

The nominal exchange rate is

A) the difference between a country's imports and exports
B) the price of a loan, expressed as a percentage
C) the rate at which labor substitutes for capital in the production function
D) the rate at which one currency can be traded for another
E) the number of times a dollar changes hands for transactions in a given period

Question 19

Imagine that the dollar appreciates 10% against the Euro and depreciates 10% against the Yen.If dollar trade weights are 75% against the Euro and 25% against the Yen,what has happened to the dollar effective exchange rate?

A) It is unchanged
B) It has appreciated by about 5%
C) It has appreciated by about 10%
D) It has depreciated by about 5%
E) It has depreciated by about 10%

Question 20

For which of the following goods would the law of one price most likely hold?

A) milk in Seattle, Washington and milk in Portland, Oregon
B) energy in Sacramento, California and energy in New Orleans, Louisiana
C) subway rides in New York, New York and subway rides in Toronto, Ontario
D) clothing in Bangor, Maine and clothing in Los Angeles, California
E) shoes in Vancouver, British Columbia and shoes in Miami, Florida

Question 21

The next questions refer to the following.
During a common base period, a basket of goods costs C$14,700 in Canada and US$10,000 in the US.
Then purchasing power parity theory predicts that

A) the real exchange rate will be 1.47
B) the US will experience 4.7% more inflation annually than Canada for 10 years
C) C$1 should exchange nominally for US$0.68
D) the Canadian dollar will depreciate by 47% against the US dollar
E) the US dollar will depreciate by 47% against the Canadian dollar

Question 22

In the 1980s there was much debate in the US concerning "twin deficits". This refers to simultaneous deficits in

A) the current account and capital account
B) the capital account and the government's budget
C) the current account and the government's budget
D) the current account and the financial account
E) the financial account and the government's budget

Question 23

Purchasing power parity is most useful

A) for predicting short run exchange rate fluctuations
B) for predicting currency fluctuations for low-inflation nations
C) for explaining long run trends in exchange rates
D) in setting targets for monetary policy
E) as an explanation of why inflation is higher in some countries than others

Question 24

If a country's investment in capital exceeds its savings,

A) its interest rate must be above the equilibrium level
B) it has a capital account surplus
C) it is a net lender in the global market
D) it has reached a steady state
E) its government is running a budget deficit

Question 25

If a nation has a capital account deficit,

A) its national debt in increasing
B) it also has a current account surplus
C) its government is running a budget deficit
D) its net exports are negative
E) its investment exceeds its savings

Question 26

An increase in a country's real exchange rate

A) makes imports more affordable
B) causes net exports to rise
C) reduces the balance in the capital account
D) reduces the purchasing power of that country's currency
E) reduces the differential between real and nominal GDP

Question 27

An economy in which GDP = 900,C = 600,T = 100,I = 100,G = 300,and there is no net income on foreign accounts must have

A) exports equal to imports
B) saving in excess of investment by 200
C) a capital account deficit of 200
D) net exports of 100
E) a current account deficit of 100

Question 28

The next questions refer to the following.
During a common base period, a basket of goods costs C$14,700 in Canada and US$10,000 in the US.
If,in the following year,Canada experiences 5% inflation while the US experiences 3% inflation,purchasing power parity theory predicts that

A) the US dollar will appreciate until US$1 = C$1.50
B) the Canadian dollar will appreciate by 2% against the US dollar
C) in the long run, the nominal value of a US dollar will equal one Canadian dollar
D) in the long run, the real trade-weighted exchange rate will be C$2 = US$3
E) the Canadian dollar will depreciate indefinitely, until the currency is worthless

Question 29

A country's current account does not include

A) income repatriated from operations overseas
B) foreign direct investment
C) net transfers from abroad
D) net exports of services
E) net exports of goods

Question 30

A nation with a current account surplus

A) imports more than it exports
B) is a net borrower
C) has a future account shortage
D) has a positive level of net exports
E) has a price floor set above equilibrium

Question 31

A country's net international investment position (IIP) increases when

A) its exports of goods and services exceed its imports
B) its sells more financial assets than it buys
C) it receives foreign direct investment
D) it runs a capital account surplus
E) its balance of payments declines

Question 32

The next questions refer to the following.
Consider a country that, during a given year, has
$20 billion in net exports of goods,
-$3 billion in net exports of services,
$3 billion in repatriated income,
-$7 billion in net overseas transfers,
-$25 billion in net direct investment,
$41 billion in net portfolio investment,
-$10 billion in other net investment, and no additional capital account transactions.
This country is running

A) a current account surplus of $13 billion
B) a current account deficit of $7 billion
C) a capital account surplus of $28 billion
D) a financial account deficit of $6 billion
E) a financial account surplus of $35 billion

Question 33

As an international price index for studying purchasing power parity,the Economist's "Big Mac Index" suffers from several defects. A graduate student in Economics wishes to construct a somewhat better index. Among the following choices,the most suitable output for this purpose would be

A) a haircut
B) a laptop computer
C) a two-bedroom apartment
D) a basket of goods consisting of a Dunlop radial tire, a 60-watt General Electric light bulb, a Nokia cell phone, and a 12-ounce can of Coca Cola
E) a basket of goods and services consisting of one acre of undeveloped land, a one-mile taxi cab ride, a one-year government bond, and one gallon of milk

Question 34

Which of the following countries has increasingly accumulated net foreign assets over the past 3 decades?

A) US
B) UK
C) Germany
D) Japan
E) Israel

Question 35

According to which of the following concepts should a currency's nominal exchange value be inversely related to the domestic price level?

A) pricing to market
B) both exchange rate pass-through and purchasing power parity
C) border effects and the law of one price
D) covered interest parity
E) the Balassa-Samuelson effect

Question 36

Which of the following would be subtracted from Italy's financial account?

A) Ford Motor Company builds a factory in Rome
B) 1.2 million Ford autos are imported by Italy
C) an Italian bank buys $0.5 million in Ford Motor Co. bonds
D) Ford opens a Eurodollar account at an Italian bank
E) Ford repatriates $1 million in profits to the US from its Italian operations

Question 37

Price inflation in non-tradable output due to productivity enhancements in tradable output is explained by

A) Stolper-Samuelson theory
B) Balassa-Samuelson theory
C) Ricardian equivalence
D) Hecksher-Ohlin theory
E) The Harrod-Domar model

Question 38

The next questions refer to the following.
Consider a country that, during a given year, has
$20 billion in net exports of goods,
-$3 billion in net exports of services,
$3 billion in repatriated income,
-$7 billion in net overseas transfers,
-$25 billion in net direct investment,
$41 billion in net portfolio investment,
-$10 billion in other net investment, and no additional capital account transactions.
This country is most likely

A) experiencing a balance of payments crisis
B) accumulating $19 billion in foreign reserves
C) reducing its holding of foreign reserves by $7 billion
D) missing $11 billion in errors and omissions
E) borrowing $4 billion from the IMF

Question 39

An empirical fact that runs counter to purchasing power parity theory is

A) that in the long run, the real exchange rate is one
B) that nations experiencing hyperinflation also experience nominal currency depreciations
C) the law of one price
D) that developing nations have lower price levels than developed nations
E) that gold has essentially the same value throughout the world

Question 40

Which of the following conditions would inhibit the Balassa-Samuelson effect?

A) Slower productivity growth in services than manufacturing
B) A relatively large service sector compared to the manufacturing sector
C) The inability to import or export services
D) The immobility of labor between manufacturing and service sectors
E) Technological improvements in manufacturing

Question 41

The short run deterioration and long run improvement of the current account following a real depreciation of currency is called

A) the J curve
B) the Laffer curve
C) the Phillips curve
D) the IS curve
E) the LM curve

Question 42

If Mexico imports British cars,then on the world market

A) the demand for pesos rises and demand for pounds falls
B) the supply of pounds rises and demand for pounds falls
C) the demand for pounds rises and the supply of pesos rises
D) the supply of pesos falls and demand for pesos rises
E) the supply of pesos rises and the supply of pounds falls