mt2_fall_2007_q1_sol - Solutions 1 For each of the...

Solutions
1. For each of the following statements, indicate whether the statement is true , or
false and justify your answer. Unjustified responses will receive a grade
of zero . Each question is worth 5 points.
(a) Poutine is the quintessential Canadian comfort food. Americans make fun
of it, but then they fill the trunks of their cars with it, smuggle it across
the border, and sell it to their friends. In Montreal a dish of the finest
quality poutine costs CAD 7.00. In Burlington, Vermont a similar dish of
poutine costs USD 8.00. The CAD/USD exchange rate is 0.90.
Statement . PPP holds for the Canadian and U.S. dollars, in terms of
poutine.
FALSE. The PPP price of poutine is 7.78, not 8.00.
(b) Suppose that Americans — tired of their tired old U.S. dollar — decided
to peg USD to CAD using a currency board system with CAD as the
reserve currency. At first, things work well and USD prices are stable.
Afterwards, the situation changes. All the USD previously used in the
international drug trade finds its way back into the U.S..