Question 1

If over the next year the inflation rate in the euro area is higher than the inflation rate in Japan, then the euro should depreciate relative to the Japanese yen.

Accepted Answer

If the inflation rate in the euro area is higher than the inflation rate in Japan, then the purchasing power of the euro will decrease relative to the Japanese yen. This will make the euro less valuable relative to the yen, and the euro should depreciate relative to the yen.

Question 2

Other things the same, an increase in the U.S. real exchange rate makes U.S. goods more expensive relative to foreign goods.

Accepted Answer

An increase in the U.S. real exchange rate means that more foreign currency is needed to purchase a given amount of U.S. goods, making U.S. goods more expensive relative to foreign goods.

Question 3

When the central bank of some country prints large quantities of money, that county's currency loses value both in terms of the goods and services it buys and in terms of the amount of foreign currencies it can buy.

Accepted Answer

Printing large quantities of money typically leads to inflation, which reduces the purchasing power of the currency both domestically (buying fewer goods and services) and internationally (decreasing its value against foreign currencies).

Question 4

Many economists believe that the theory of purchasing-power parity describes the forces that determine exchange rates in the long run.

Accepted Answer

Purchasing-power parity (PPP) theory posits that in the long run, exchange rates should adjust so that an identical good in two different countries has the same price when expressed in a common currency. This theory is widely accepted among economists as a fundamental principle that explains long-term determinants of exchange rates.

Question 5

If foreign residents purchase 30 billion pesos of Mexican assets and Mexican residents purchase 25 billion pesos of foreign assets, then Mexico has a net capital outflow of 5 billion pesos.

Accepted Answer

Net capital outflow is calculated as the difference between the purchase of foreign assets by residents and the purchase of domestic assets by foreigners. In this case, it would be -5 billion pesos, indicating a net capital inflow, not outflow.

Question 6

According to purchasing power parity, the nominal exchange rate between the U.S. and another country should equal the price level of foreign goods divided by the price level of U.S. goods.

Accepted Answer

Purchasing Power Parity (PPP) theory states that in the absence of transaction costs and barriers to trade, the nominal exchange rate between two countries should equal the ratio of the price levels in those countries, effectively making the cost of a basket of goods the same in both countries when priced in a common currency.

Question 7

If the purchasing power of the dollar is always the same at home and abroad, then the nominal exchange rate defined as units of foreign currency per dollar decreases if the U.S. price level rises more than the price level in foreign countries.

Accepted Answer

If the U.S. price level rises more than the foreign price level, the purchasing power of the dollar decreases, leading to a depreciation of the dollar, which means fewer units of foreign currency per dollar.

Question 8

Other things the same, an increase in domestic prices raises the real exchange rate.

Accepted Answer

An increase in domestic prices, while foreign prices remain constant, increases the real exchange rate because the domestic currency now buys less of the foreign goods, indicating a depreciation of the real value of the domestic currency relative to the foreign currency.

Question 9

In the 1970s and 1980s the U.S. dollar depreciated against the German mark and appreciated against the Italian lira because U.S. inflation was lower than in Germany but higher than in Italy.

Accepted Answer

The U.S. dollar would depreciate against a currency from a country with lower inflation and appreciate against a currency from a country with higher inflation, due to the purchasing power parity theory.

Question 10

Other things the same, an increase in the real exchange rate raises U.S. net exports.

Accepted Answer

An increase in the real exchange rate makes U.S. goods more expensive relative to foreign goods, which tends to decrease U.S. exports and increase imports, thereby reducing U.S. net exports.

Question 11

If prices in the U.S. rise faster than prices in the United Kingdom, then according to the doctrine of purchasing-power parity the U.S. nominal exchange rate should rise

Accepted Answer

According to the doctrine of purchasing-power parity, if prices rise faster in the U.S. than in the United Kingdom, the U.S. dollar should depreciate (not appreciate) relative to the British pound, making U.S. goods cheaper for British consumers and British goods more expensive for American consumers, thereby restoring purchasing power parity.

Question 12

Jason plans to buy shrimp in Florida and sell them in Manhattan, Kansas where the price is higher. Jason plans to engage in arbitrage.

Accepted Answer

Arbitrage involves buying a product in one market at a lower price and selling it in another market at a higher price to profit from the price difference, which is exactly what Jason plans to do.

Question 13

Other things the same, an increase in foreign prices raises the real exchange rate.

Accepted Answer

An increase in foreign prices relative to domestic prices would actually lower the real exchange rate, making domestic goods relatively more expensive compared to foreign goods.

Question 14

According to purchasing-power parity theory, the nominal exchange rate between the U.S. and another country should equal the U.S. price level divided by the price level in the foreign country.

Accepted Answer

According to purchasing-power parity (PPP) theory, the nominal exchange rate between two countries should equal the ratio of the foreign price level to the U.S. price level, not the U.S. price level divided by the foreign price level.

Question 15

If U.S. residents purchase $450 billion of foreign assets and foreigners purchase $575 billion of U.S. assets, then the U.S. has net capital outflows of -$125 billion and a trade deficit of $125 billion.

Accepted Answer

Net capital outflows are calculated as the difference between the purchase of foreign assets by U.S. residents and the purchase of U.S. assets by foreigners. A negative net capital outflow of -$125 billion indicates a capital inflow, which corresponds to a trade deficit of the same amount.

Question 16

Other things the same, an increase in the foreign price level leads to an increase in the real exchange rate.

Accepted Answer

An increase in the foreign price level, other things being equal, would decrease the real exchange rate, as the real exchange rate is the relative price of domestic goods in terms of foreign goods. Higher foreign prices make foreign goods more expensive relative to domestic goods.

Question 17

If prices in Mexico rise at a higher rate than prices in the U.S., then according to purchasing-power parity the U.S. nominal exchange rate with Mexico should rise.

Accepted Answer

According to purchasing-power parity (PPP), if prices in Mexico rise faster than in the U.S., the Mexican peso should depreciate relative to the U.S. dollar, causing the nominal exchange rate (USD/MXN) to rise.

Question 18

If the U.S. real exchange rate is greater than 1, then there is the possibility of arbitraging by buying foreign goods to sell in the U.S.

Accepted Answer

When the U.S. real exchange rate is greater than 1, it means that U.S. goods are relatively more expensive compared to foreign goods. This creates an opportunity for arbitrage by purchasing cheaper foreign goods and selling them at a higher price in the U.S. market.

Question 19

The theory of purchasing-power parity states that a unit of a country's currency should be able to buy the same quantity of goods in foreign countries as it does in the domestic economy.

Accepted Answer

Purchasing-power parity (PPP) theory posits that in the absence of transaction costs and barriers to trade, the exchange rate between two currencies should equalize the price of a basket of goods and services in each country, allowing a unit of currency to have the same purchasing power in different countries.

Question 20

Purchasing-power parity says that the nominal exchange rate must equal the real exchange rate.

Accepted Answer

Purchasing-power parity (PPP) theory states that in the long run, exchange rates should adjust so that the same basket of goods costs the same amount in two different countries when priced in the same currency. It does not imply that the nominal exchange rate must equal the real exchange rate; rather, it suggests that the real exchange rate should approach parity (equality in purchasing power) over time.

Quiz 31: Open-Economy Macroeconomics: Basic Concepts