Practice Questions 2.1 - 1 Practice Questions for Topic...

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1 Practice Questions for Topic 2.1 (Chapter 16) I. Suggested MyEconLab questions: Chapter 16 Section 16.1: Exercise 1.1, Exercise 1.2, Exercise 1.3 Section 16.2: Chapter Problem 1 Section 16.3: Exercise 3.1 Section 16.5: Exercise 5.2 Section 16.6: Chapter Problem 3 II. Other questions: NOTE: Answers to all of the following questions follow on pages 5-8. 1. The table below contains hypothetical figures in each of 3 years for 3 variables: 1) the exchange rate between the Canadian dollar and the U.S. dollar ( E C $/US$ ); 2) the US$ price of a basket of goods and services purchased in the U.S. ( P us ); 3) the C$ price of the same basket of goods if purchased in Canada ( P c ). Year E C $/US$ P us P c 1 1.200 100.0 150.0 2 1.188 103.0 153.0 3 1.307 103.0 168.3 i) Is the data in the above table consistent with the predictions of the theory of Absolute Purchasing Power Parity? Why, or why not? ii) Is the data in the above table consistent with the predictions of the theory of Relative Purchasing Power Parity? Why, or why not? iii) What are the values of the real exchange rate ( q C/US ) in these years? 2. Below are 3 years of hypothetical values for 3 variables: 1) the annual rate of interest on a euro deposit expressed in decimal form ( R ); 2) the actual annual rate of price inflation in Europe ( π E ); 3) the actual annual rate of price inflation in Canada ( π C ) Year R π E π C ( E e $/€ - E $/€ )/ E $/€ R $ 1 0.03 0.00 0.00 2 0.03 0.00 0.02 3 0.06 0.03 0.02 Assume the following: a) Relative purchasing power parity prevails and is expected to prevail. b) Inflation is everywhere fully anticipated. c) Interest rate parity prevails.
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2 i) Given these assumptions, for each of these years fill in the blanks in the table by calculating 1) the corresponding expected annual rate of change of the Canadian dollar- euro exchange rate 2) the nominal interest rate in Canada. ii) Explain your calculations. 3. Consider two economies which we will simply refer to as the “domestic economy” and the “foreign economy,” respectively. Assume that up to time t 0 the two economies are in a long- run equilibrium in which the nominal money supply is increasing in both countries at a constant annual rate of 3% resulting in a constant and equal annual rate of price inflation in both countries of 3%: Δ M/M = Δ M*/M * = 0.03; π = π * = 0.03 Assume that the foreign rate of interest is 5% ( R * = 0.05). Assume both purchasing power parity and interest rate parity prevail and are expected to prevail and inflation is perfectly anticipated. i)
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This note was uploaded on 02/02/2012 for the course ECONOMICS 239 taught by Professor Wu during the Winter '11 term at Wilfred Laurier University .

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Practice Questions 2.1 - 1 Practice Questions for Topic...

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