homework12 - 6 In 1900 the exchange rate between the pound...

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Problem Set 12 1. Define the concept of purchasing power parity. What is the purchasing power parity (PPP) hypothesis? 2. Does the empirical evidence indicate that the PPP hypothesis always holds in the short run, never holds in the short run, or sometimes holds in the short run? 3. Does the PPP hypothesis about exchange rate determination hold in the long run (exactly or fairly closely)? 4. What is the equation of exchange and what is the quantity theory of money? Why is the quantity theory of money a theory of the general level of prices in an economy? 5. Use the quantity theory of money to explain how the exchange rate between two countries’ currencies will change over time when (a) the money supply in both countries is increasing at the same percentage rate, but real output is increasing more rapidly in one country than in the other and (b) when the money supply growth rate in one country is much faster than the other although real output is growing at the same percentage rate in both countries.
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Unformatted text preview: 6. In 1900, the exchange rate between the pound sterling (the British pound) and the US dollar was about $5 to the pound. In 2012, the exchange rate is about $1.60 to the pound. Using the PPP hypothesis, provide an explanation of why the value of the dollar has appreciated by about 200% over the past 110 years. 7. Define the concept of the real exchange rate between two currencies. Why would you expect the real exchange rate to always tend to equal about 1? 8. Suppose the nominal exchange rate between the US dollar and the Japanese yen is 90 Yen per dollar. If a diamond ring (a representative commodity) costs 100,000 yen in Tokyo and $1,000 in New York, is the real exchange rate between the two countries equal to 1, greater than 1 or less than 1 (where the home currency is the US dollar)? What would you expect to happen to the nominal exchange rate between the two currencies, and why (assuming that the prices of a diamond ring in New York and Tokyo do not change)?...
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