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InternationalEconomics,8e(Krugman)

Chapter15PriceLevelsandtheExchangeRateintheLongRun

15.1TheLawofOnePrice

1)Whichofthefollowingstatementsisthemostaccurate?Thelawofonepricestates:

A)incompetitivemarketsfreeoftransportationcostsandofficialbarriertotrade,identicalgoodssoldin

differentcountriesmustsellforthesamepricewhentheirpricesareexpressedintermsofthesame

currency.

B)incompetitivemarketsfreeoftransportationcostsandofficialbarriertotrade,identicalgoodssoldin

thesamecountrymustsellforthesamepricewhentheirpricesareexpressedintermsofthesame

currency.

C)incompetitivemarketsfreeoftransportationcostsandofficialbarriertotrade,identicalgoodssoldin

differentcountriesmustsellforthesameprice.

D)identicalgoodssoldindifferentcountriesmustsellforthesamepricewhentheirpricesareexpressed

intermsofthesamecurrency.

E)Noneoftheabove.

Answer:A

QuestionStatus:PreviousEdition

2)UnderPurchasingPowerParity,

A)E$/E=PUS/PE.

B)E$/E=PE/PES.

C)E$/E=Pus+PE.

D)E$/E=Pus-PE-

E)Noneoftheabove.

Answer:A

QuestionStatus:PreviousEdition

3)ExplaintheLawofOnePrice.Giveanexample.

Answer:Thelawofonepricestatesthatincompetitivemarketsfreeoftransportationcostsandtradebarriers,

identicalgoodssoldindifferentcountriesmustsellforthesamepricewhenexpressedintermsofthe

samecurrency.

Pus=(E$/￡)x(p2)forgoodi.

E$/￡=Pus/pUK

If,forexample,thepriceofthesamesweaterwascheaperinLondonthaninNewYork,U.S.importers

andBritishexporterswouldhaveanincentivetobuysweatersinLondonandshipthemtoNewYork,

pushingtheLondonpriceupandtheNewYorkpricedown,untilbothwereequal.

QuestionStatus:PreviousEdition

1

4)Fillinthefollowingtable,assumingthelawofonepriceprevails.

PriceintheUnitedStates

ofaSweaterExpressedinPriceinEuropeExchangeRateBehveenthe

Dollars,pi(jSExpressedinEuro,DollarandtheEuro,坊/E

25320.78125

350.833333333

4554

650.846153846

650.82278481

850.882352941

850.787037037

950.871559633

115139

Answer:____________________________________________________________

PriceintheUnitedStates

ofaSweaterExpressedinPriceinEuropeExchangeRateBehveenthe

Dollars,pifjSExpressedinEuro,DollarandtheEuro,E$/￡

25320.78125

35420.833333333

45540.833333333

55650.846153846

65790.82278481

75850.882352941

851080.787037037

951090.871559633

1151390.827338129

QuestionStatus:PreviousEdition

15.2PurchasingPowerParity

1)UnderPurchasingPowerParity,

A)E$/E=Pius/FdE-

B)E$/E=PiE/PiuS.

C)E$/E=PUS/PE.

D)E$/E=PE/PES.

E)Noneoftheabove.

Answer:C

QuestionStatus:PreviousEdition

2)Whichofthefollowingstatementsisthemostaccurate?

A)Thelawofonepriceappliesonlytothegeneralpricelevel.

B)ThelawofonepriceappliestothegeneralpricelevelwhilePPPappliestoindividualcommodities.

C)ThelawofonepriceappliestoindividualcommoditieswhilePPPappliestoboththegeneralprice

levelandtoindividualcommodities.

D)PPPappliesonlytoindividualcommodities.

E)ThelawofonepriceappliestoindividualcommoditieswhilePPPappliestothegeneralpricelevel.

Answer:E

QuestionStatus:PreviousEdition

2

3)Whichofthefollowingstatementsisthemostaccurate?

A)IfPPPholdstrue,thenthelawofonepriceholdstrueforeverycommodityaslongasthereference

basketsusedtoreckondifferentcountries'pricelevelsarethesame.

B)Ifthelawofonepriceholdstrueforeverycommodity,PPPmustholdautomatically.

C)Ifthelawofonepriceholdstrueforeverycommodity,PPPmustautomaticallyholdaslongasthe

referencebasketsusedtoreckondifferentcountries*pricelevelsarethesame.

D)Ifthelawofonepricedoesnotholdtrueforeverycommodity,PPPcannotbetrueaslongasthe

referencebasketsusedtoreckondifferentcountries*pricelevelsarethesame.

E)Noneoftheabove.

Answer:C

QuestionStatus:PreviousEdition

4)Whichofthefollowingstatementsisthemostaccurate?

A)AbsolutePPPdoesnotimplyrelativePPP.

B)RelativePPPimpliesabsolutePPP.

C)Thereisnocausalityrelationbetweenthetwo.

D)AbsolutePPPimpliesrelativePPP.

E)Noneoftheabove.

Answer:D

QuestionStatus:PreviousEdition

5)Whichofthefollowingstatementsisthemostaccurate?

A)RelativePPPmaybevalidevenwhenabsolutePPPisnot,providedthefactorscausingdeviationsfrom

absolutePPParemoreorlessstableoverdifferentcommoditiesspace.

B)AbsolutePPPmaybevalidevenwhenrelativePPPisnot,providedthefactorscausingdeviationsfrom

relativePPParemoreorlessstableovertime.

C)RelativePPPmaybevalidevenwhenabsolutePPPisnot,providedthefactorscausingdeviationsfrom

absolutePPParemoreorlessstableovertime.

D)RelativePPPisnotvalidwhenabsolutePPPisnot.

E)Noneoftheabove.

Answer:C

QuestionStatus:PreviousEdition

6)ExplainPurchasingPowerParity.

Answer:PPPstatesthattheexchangeratebetweentwocountries'currenciesequalstheratioofthecountries*

pricelevels.

Afallinacurrency'sdomesticpurchasingpower(i.e.anincreaseinthedomesticpricelevel)willbe

associatedwithaproportionalcurrencydepreciationintheforeignexchangemarketandviceversa.

E$/e二PUS/PEwherePisthepriceofareferencecommoditybasket.

Rearrange:Pus=E$/^x(PE)

Thus,PPPassertsthatallcountries'pricelevelsareequalwhenmeasuredintermsofthesame

currency.

QuestionStatus:PreviousEdition

7)DiscusstherelationshipbetweenPPPandtheLawofOnePrice.

Answer:ThelawofonepriceappliestoindividualcommoditieswhilePPPappliestothegeneralpricelevel.

ProponentsofPPParguethatitsvalidityinthelongrundoesn'trequirethelawofonepricetohold

exactly.Whengoodsandservicestemporarilybecomemoreexpensiveinonecountrythaninothers,

thedemandsforitscurrencyanditsproductsfalls,pushingtheexchangerateanddomesticprices

backinlinewithPPPandviceversa.

QuestionStatus:PreviousEdition

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8)DiscussthedifferencesbetweenAbsolutePPPandRelativePPP.

Answer:AbsolutePPPstatesthattheexchangeratebetweentwocurrenciesequalstheratiooftheirpricelevels.

RelativePPPstatesthatthepercentagechangeintheexchangeratebetweentwocurrenciesovera

givenperiodequalsthedifferencebetweentheinflationratesofthosetwocurrencies.

QuestionStatus:PreviousEdition

9)ExplainwhyRelativePPPisusefulwhencomparingcountriesthatbasetheirpricelevelsondifferent

productbaskets.

Answer:ForExample:IftheU.S.pricelevelrisesby10%overayearwhileEurope'srisesbyonly5%,relative

PPPpredictsa5%depreciationofthedollaragainsttheeuro.Thisjustcancelsthe5%bywhichU.S.

inflationexceedsEuropean,leavingtherelativedomesticandforeignpurchasingpowersofboth

currenciesunchanged.

(E$/e,t-E$/w,t-l)/E$/e,t-l=(ne)US,t-(ne)E,tbetweendatestandt-1.

RelativePPPisusefulwhencomparingcountriesthatbasetheirpricelevelsondifferentproduct

baskets.RelativePPPmaybevalidevenwhenabsolutePPPisnot.

QuestionStatus:PreviousEdition

10)SupposeRussia'sinflationrateis200%overoneyearbuttheinflationrateinSwitzerlandisonly2%.

AccordingtorelativePPP,whatshouldhappenovertheyeartotheSwissfranc'sexchangerateagainstthe

Russianruble?

Answer:(Eruble/franc,t?Eruble/franc,t-1)/Eruble/franc,t-1=2-0.02=1.98

Sotherewillbea198%depreciationoftherubleagainstthefrancor,conversely,a198%appreciation

ofthefrancagainsttheruble.

QuestionStatus:PreviousEdition

4

11)AssumingrelativePPP,fillinthetablebelow:

E$/E,tE$/E,t-1nus,t叫t

20.03-0.08111

2.120.04-0.01

2.22.10.002381

2.20.060.014545

2.40.070.026522

2.52.40.08

2.62.50.05

2.72.60.10.061538

2.70.110.072963

2.92.80.084286

32.90.13

Answer:Using(E$/et-E$/et4)/E$/eM=Hus,t-tonegets:

E$/E,tE$/E,t-1□us,t叫t

21.80.03-0.08111

2.120.04-0.01

2.22.10.050.002381

2.32.20.060.014545

2.42.30.070.026522

2.52.40.080.038333

2.62.50.090.05

2.72.60.10.061538

2.82.70.110.072963

2.92.80.120.084286

32.90.130.095517

QuestionStatus:PreviousEdition

15.3ALong-RunExchangeRateModelBasedonPPP

1)InorderfortheconditionE$/HK$-Pus/^HKtohold,whatassumptionsdoestheprincipleofpurchasing

powerparitymake?

A)Notransportationcostsandrestrictionsontrade;commoditybasketsthatareareliableindicationof

pricelevel.

B)Marketsareperfectlycompetitive,i.e.,P=MC.

C)Thefactorsofproductionareidenticalbetweencountries.

D)Noarbitrageexists.

E)AandB.

Answer:E

QuestionStatus:PreviousEdition

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2)Whichofthefollowingstatementsisthemostaccurate?

A)Inthelongrun,nationalpricelevelsplayaminorroleindeterminingbothinterestratesandthe

relativepricesatwhichcountries'productsaretraded.

B)Inthelongrun,nationalpricelevelsplayakeyroleonlyindetermininginterestrates.

C)Inthelongrun,nationalpricelevelsplayakeyroleonlyindeterminingtherelativepricesatwhich

countries'productsaretraded.

D)Inthelongrun,nationalpricelevelsplayakeyroleindeterminingbothinterestratesandtherelative

pricesatwhichcountries*productsaretraded.

E)Noneoftheabove.

Answer:D

QuestionStatus:PreviousEdition

3)Whichofthefollowingstatementsisthemostaccurate?Ingeneral,

A)themonetaryapproachtotheexchangerateisalongruntheory.

B)themonetaryapproachtotheexchangerateisashortruntheory.

C)themonetaryapproachtotheexchangerateisbothashortandlongruntheory.

D)themonetaryapproachtotheexchangerateneitherlongrunnorshortruntheory.

E)Noneoftheabove.

Answer:A

QuestionStatus:PreviousEdition

4)Themonetaryapproachmakesthegeneralpredictionthat

A)theexchangerate,whichistherelativepriceofAmericanandEuropeanmoney,isfullydeterminedin

thelongrunbytherelativesuppliesofthosemonies.

B)theexchangerate,whichistherelativepriceofAmericanandEuropeanmoney,isfullydeterminedin

theshortrunbytherelativesuppliesofthosemoniesandtherelativedemandsforthem.

C)theexchangerate,whichistherelativepriceofAmericanandEuropeanmoney,isfullydeterminedin

theshort-andlongrunbytherelativesuppliesofthosemoniesandtherelativedemandsforthem.

D)theexchangerate,whichistherelativepriceofAmericanandEuropeanmoney,isfullydeterminedin

thelongrunbytherelativesuppliesofthosemoniesandtherelativedemandsforthem.

E)Noneoftheabove.

Answer:D

QuestionStatus:PreviousEdition

5)Underthemonetaryapproachtotheexchangeratetheory,moneysupplygrowthataconstantrate

A)eventuallyresultsinongoingpriceleveldeflationatthesamerate,butchangesinthislong-run

deflationratedonotaffectthefull-employmentoutputlevelorthelong-runrelativepricesofgoods

andservices.

B)eventuallyresultsinongoingpricelevelinflationatthesamerate,butchangesinthislong-runinflation

ratedoaffectthefull-employmentoutputlevelandthelong-runrelativepricesofgoodsandservices.

C)eventuallyresultsinongoingpricelevelinflationatthesamerate,butchangesinthislong-runinflation

ratedonotaffectthefull-employmentoutputlevelorthelong-runrelativepricesofgoodsandservices.

D)eventuallyresultsinongoingpricelevelinflationatthesamerate,butchangesinthislong-runinflation

ratedonotaffectthefull-employmentoutputlevel,onlythelong-runrelativepricesofgoodsand

services.

E)Noneoftheabove.

Answer:C

QuestionStatus:PreviousEdition

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6)Whichofthefollowingstatementsisthemostaccurate?Ingeneral,underthemonetaryapproachtothe

exchangerate,

A)theinterestrateisnotindependentofthemoneysupplygrowthrateintheshortrun.

B)theinterestrateisindependentofthemoneysupplygrowthrateinthelongrun.

C)theinterestrateisnotindependentofthemoneysupplygrowthrateinthelongrun,butindependent

intheshortrun.

D)theinterestrateisnotindependentofthemoneysupplygrowthrateinthelongrun.

E)Noneoftheabove.

Answer:D

QuestionStatus:PreviousEdition

7)Whichofthefollowingstatementsisthemostaccurate?Ingeneral,underthemonetaryapproachtothe

exchangerate,

A)whiletheshort-runinterestratedoesnotdependontheabsolutelevelofthemoneysupply,continuing

growthinthemoneysupplyeventuallywillaffecttheinterestrate.

B)whilethelong-runinterestratedoesdependontheabsolutelevelofthemoneysupply,continuing

grozvthinthemoneysupplydonotaffecttheinterestrate.

C)whilethelong-runinterestratedoesnotdependontheabsolutelevelofthemoneysupply,continuing

growthinthemoneysupplyeventuallywillaffecttheinterestrate.

D)thelong-runinterestratedoesnotdependontheabsolutelevelofthemoneysupply,andthus

continuinggrowthinthemoneysupplywillnotaffecttheinterestrate.

E)Noneoftheabove.

Answer:C

QuestionStatus:PreviousEdition

8)Whoamongthefollowinglistofpeopleisanearly20thcenturyeconomistfromYaleUniversitywhowrote

thebookTheTheoryofInterest?

A)GustavCassel

B)IrvingFisher

C)DavidRicardo

D)PaulKrugman

E)Noneoftheabove.

Answer:B

QuestionStatus:New

9)IfpeopleexpectrelativePPPtohold,

A)thedifferencebetweentheinterestratesofferedbydollarandeurodepositswillequalthedifference

betweentheinflationratesexpected,intheUnitedStatesandEurope,respectively,overtherelevant

horizon.

B)thedifferencebetweentheinterestratesofferedbydollarandeurodepositswillequalthedifference

betweentheinflationratesexpectedinEuropeandtheUnitedStates,respectively.

C)thedifferencebetweentheinterestratesofferedbydollarandeurodepositswillequalthedifference

betweentheinflationratesexpected,overtherelevanthorizon,intheUnitedStatesandEurope,

respectively,intheshortrun.

D)thedifferencebetweentheinterestratesofferedbydollarandeurodepositswillbeabovethedifference

betweentheinflationratesexpected,overtherelevanthorizon,intheUnitedStatesandEurope,

respectively.

E)Noneoftheabove.

Answer:A

QuestionStatus:PreviousEdition

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10)UnderPPP(andbytheFisherEffect),allelseequal,

A)ariseinacountry'sexpectedinflationratewilleventuallycauseamore-thanproportionalriseinthe

interestratethatdepositsofitscurrencyofferinordertoaccommodateforthehigherinflation.

B)afallinacountry'sexpectedinflationratewilleventuallycauseanequalriseintheinterestratethat

depositsofitscurrencyoffer.

C)ariseinacountry'sexpectedinflationratewilleventuallycauseanequalriseintheinterestratethat

depositsofitscurrencyoffer.

D)ariseinacountry'sexpectedinflationratewilleventuallycausealessthanproportionalriseinthe

interestratethatdepositsofitscurrencyoffertoaccommodatetheriseinexpectedinflation.

E)Noneoftheabove.

Answer:C

QuestionStatus:PreviousEdition

11)Intheshortrun,

A)theinterestratecanrisewhenthedomesticmoneysupplyfalls.

B)theinterestratecandecreasewhenthedomesticmoneysupplyfalls.

C)theinterestratestaysconstantwhenthedomesticmoneysupplyfalls.

D)theinterestraterisesinthesameproportionasthedomesticmoneysupplyfalls.

E)Noneoftheabove.

Answer:A

QuestionStatus:PreviousEdition

12)Underaflexible-pricemonetaryapproachtotheexchangerate,

A)whenthedomesticmoneysupplyfalls,thepricelevelwouldeventuallyfall,increasingtheinterestrate.

B)whenthedomesticmoneysupplyfalls,thepricelevelwouldfallrightaway,causingareductioninthe

interestrate.

C)whenthedomesticmoneysupplyfalls,thepricelevelwouldfallrightaway,causinganincreaseinthe

interestrate.

D)whenthedomesticmoneysupplyfalls,thepricelevelwouldeventuallyfall,keepingtheinterestrate

constant.

E)whenthedomesticmoneysupplyfalls,thepricelevelwouldfallrightaway,keepingtheinterestrate

constant.

Answer:E

QuestionStatus:PreviousEdition

13)Understickyprices,

A)afallinthemoneysupplyraisestheinterestratetopreservemoneymarketequilibrium.

B)afallinthemoneysupplyreducestheinterestratetopreservemoneymarketequilibrium.

C)afallinthemoneysupplykeepstheinterestrateintacttopreservemoneymarketequilibrium.

D)afallinthemoneysupplydoesnotaffecttheinterestrateintheshortrun,onlyinthelongrun.

E)Noneoftheabove.

Answer:A

QuestionStatus:PreviousEdition

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14)Understickyprices,

A)aninterestrateriseisassociatedwithlowerexpecteddeflationandalong-runcurrencyappreciation,

sothecurrencyappreciatesimmediately.

B)aninterestrateriseisassociatedwithhigherexpectedinflationandalong-runcurrencyappreciation,

sothecurrencyappreciatesimmediately.

C)aninterestrateriseisassociatedwithlowerexpectedinflationandalong-runcurrencydepreciation,so

thecurrencyappreciatesimmediately.

D)aninterestrateriseisassociatedwithlowerexpectedinflationandalong-runcurrencydepreciation,so

thecurrencydepreciatesimmediately.

E)aninterestrateriseisassociatedwithlowerexpectedinflationandalong-runcurrencyappreciation,so

thecurrencyappreciatesimmediately.

Answer:E

QuestionStatus:PreviousEdition

15)Underthemonetaryapproachtotheexchangerate,

A)aninterestratedecreaseisassociatedwithhigherexpectedinflationandacurrencythatwillbeweaker

onallfuturedates.

B)aninterestrateincreaseisassociatedwithhigherexpecteddeflationandacurrencythatwillbeweaker

onallfuturedates.

C)aninterestrateincreaseisassociatedwithhigherexpectedinflationandacurrencythatwillbe

strengthenedonallfuturedates.

D)aninterestrateincreaseisassociatedwithhigherexpecteddeflationandacurrencythatwillbe

strengthenedonallfuturedates.

E)aninterestrateincreaseisassociatedwithhigherexpectedinflationandacurrencythatwillbeweaker

onallfuturedates.

Answer:E

QuestionStatus:PreviousEdition

16)Underthemonetaryapproachtotheexchangerate,

A)areductioninthemoneysupplywillcauseimmediatecurrencydepreciation.

B)ariseinthemoneysupplywillcausecurrencydepreciation.

C)ariseinthemoneysupplywillcauseimmediatecurrencyappreciation.

D)ariseinthemoneysupplywillcausedepreciation.

E)ariseinthemoneysupplywillcauseimmediatecurrencydepreciation.

Answer:E

QuestionStatus:PreviousEdition

17)ExplainwhyexchangeratemodelbasedonPPPisalongruntheory.

Answer:PPPtheoryisamonetaryapproachtotheexchangerate.Itisalong-runtheorybecauseitdoesnot

allowforpricerigidities.Itassumesthatpricescanadjustrightawaytomaintainfullemploymentas

wellasPPP.

QuestionStatus:PreviousEdition

18)PresentandexplaintheFundamentalEquationoftheMonetaryApproach.

Answer:AssumeE$/^二PUS/PEandthatdomesticpricelevelsdependondomesticmoneydemandsand

supplies:

Pus=MusS/L(R$,Yus)

PE=MES/L(R6,YE)

Therefore,theexchangerateisfullydeterminedinthelongrunbytherelativesuppliesofthose

moniesandtherelativerealdemandsforthem.Shiftsininterestratesandoutputlevelsaffectthe

exchangerateonlythroughtheirinfluenceonmoneydemand.

QuestionStatus:PreviousEdition

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19)WhatarethepredictionsforthelongrunequilibriumoftheMonetaryApproach?

Answer:Moneysupplies:Giventheequations,

E$/e=PUS『E

Pus=Muss/L(R$,Yus)

s

PE=ME/L(Re,YE)

onecanshowthatanincreaseintheU.S.moneysupplyMJJS^causesaproportionalincreaseinthe

U.S.pricelevelPuS，whichinturncausesaproportionalincreaseinE$/^.Thus,anincreaseinU.S.

moneysupplycausesaproportionallong-rundepreciationofthedollaragainsttheeuroandvice

versa.

Interestrates:AriseintheinterestrateR$lowersU.S.moneydemandL(R$,Yys)therebycausinga

riseintheU.S.pricelevelandaproportionaldepreciationofthedollaragainsttheeuro.

Outputlevels:AriseinU.S.outputYuSraisesrealU.S.moneydemandleadingtoafallinthe

long-runU.S.pricelevelandanappreciationofthedollaragainsttheeuro.

QuestionStatus:PreviousEdition

20)Discussthee仔ectsofongoinginflationbasedonthePPPtheory.

Answer:Otherthingsequal,moneysupplygrowthataconstantrateeventuallyresultsinongoingpricelevel

inflationatthesamerateasthemoneysupplygrowth,butchangesinthislong-runinflationratedo

notaffectthefull-employmentoutputlevelorthelong-runrelativepricesofgoodsandservices.

Theinterestrate,however,isaffectedbycontinuinggrowthinthemoneysupply(inflation).Thiscan

beshownbycombiningPPPwiththeinterestparitycondition(refertoCh.13).

Toshowitanalyticallyrecallthattheconditionofparitybetweendollarandeuroassetsis:

+E

R$=Re($/e-E$/e)/E$/e

AndaccordingtorelativePPP:

En

($/e,t-E$/e,t-1)/E$/e,t-1=US,t-U-t

IfpeopleexpectrelativePPPtohold,thedeferencebetweeninterestratesofferedbydollarandeuro

depositswillequalthedifferencebetweentheexpec