Study Questions for Weeks 9 and 10
1. The text lists 4 economic factors that determine the exchange rate over the long run. Briefly
describe each of these factors.
2. Examine table 12.2. What does the author mean by the phrase “US productivity” and why
would this a decrease in this lead to a depreciation of the US dollar?
3. Examine Table 12.2 on page402. Explain each of the 8 outcomes (effects) on the long run
exchange rate for the US$. For each of the 8 cases, draw the corresponding S&D diagram.
4. Examine Figure 12.2 and be able to explain the examples behind each of the 4 panels.
5. State the law of one price. Suppose the price of wheat in Canada is $5 (Canadian dollars) per
bushel. The price of wheat in the US is $6 (US dollars). The exchange rate is currently $
1.00(Canadian) per US $. Is the price in Canada “too” high or “too low”? How much profit
could you make buying one bushel of wheat in Canada and selling it in the US? When traders
start buying Canadian wheat and selling it in the US, what will happen to the price of wheat
in Canada? , the price in the US?
6. Same example as number 5, except the initial exchange rate is .8 Canadian $per US $.
7. Suppose the average price of a Big Mac in the United States is $3.50 while in Japan the
average price is 400 yen. If the price of a dollar is 100 yen per dollar, the purchasing power
parity model of exchange rate determination suggests: The yen is currently (overvalued,
undervalued) and the exchange will eventually change to a rate (greater than, less than) 100
yen per US$.
8. Inspect table 12.3. According to these data for 2007, the price of a Big Mac is highest in
(__________________) .
9. Inspect table 12.3. Which currencies are overvalued the most, the least. Now check to see
what has happened over time. Inspect the Big Mac Index for 2008. Did things change as
predicted?
10. What is purchasing power parity? How is this related to the Big Mac index?
11. The chart above shows GNP per capita on the vertical axis measured using the World Bank
PPP index. Per capita GNP is on the horizontal axis. Each red dot shows the data point for one
country. The little blue circles show the 45 degree line where GNP (ppp)=GNP(not using
PPP). Countries above the 45 degree line have a GNP (ppp) higher than GNP (not ppp). Which
types of countries tend to lie above the 45 degree line? Which tend to lie below it?
The author states that the evidence presented in table 12.4 are consistent with the
predictions of PPP. Explain why these data are consistent with PPP.
12. Examine the data presented in Figure 12.3 Are these data consistent with the predictions of
PPP theory?
Examine table 12.4 and Figure 12.4. If the British interest rate increases, in the (short,
long) run, the demand for the pound will (increase, decrease) and the $/ £ (appreciate,
depreciate).
13. Examine Figure 12.4. In panel a, what causes the demand for pounds to increase? What
causes the supply curve for pounds to decrease?
14. According to your text in the late 1980’s the US dollar (appreciation, depreciation) was partly
the result of (expansionary, contractionary) monetary by the US Federal Reserve that pushed
US interest rates (higher, lower).
15. Use Figure 12.6 to explain “overshooting”.
16. According to Bernanke, what needs to be done to decrease the large US current account
deficit?