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Questions 4 - tradable sector of a rich economy is more...

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Questions 4 1. Law of one price may fail hold because of imperfect substitutes in goods, and imperfect competition in markets. Also, imperfect information, barrier to trade, tariffs, non-traded goods prices. Different inputs to goods in different countries. You get the point. 2. Hamburger standard is using the price of a big Mac to show that either PPP holds or law of one price. Doesn’t take into account demand differences or differences in production costs for big Macs in different countries. Also, big Macs are non internationally tradable 3. PPP does not hold in terms of aggregate price indices according to the BS model because non-tradable goods prices are higher in developed countries than in non- developed countries. The BS model shows us that because a worker in the
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Unformatted text preview: tradable sector of a rich economy is more productive than a worker in the tradable sector of a poor economy and wage in the tradable and non-tradable sectors are the same within each country, the relative price of non tradables to tradable will be higher in the rich country. 4. The principal difference between the asset market and portfolio balance approach to exchange rates is that the asset market approach does not incorportate risk while the pba boes. In the ama ex rates are determined by UIP (the change in the ex rate is the difference between the foreign i rate and the domestic i rate). The pba involves risk and says UIP will not hold, but we don’t know how to measure risk. 5. See book....
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