ppp

Question 1

What does Absolute Purchasing Power Parity (APPP) state

Answer 1

The general level of prices, when converted to a common currency, should be the same in every country

Question 2

What assumption is made in deriving APPP

Answer 2

No tariffs and no transportation costs, and prices follow the law of one price

Question 3

How is the real exchange rate (Q) defined

Answer 3

Q=SP/P
s- nominal exchange rate
P - foreign price level
P - domestic price level

Question 4

What does a real exchange rate value of 1 imply

Answer 4

Absolute PPP holds; purchasing power is equalized across countries

Question 5

How is Relative PPP derived

Answer 5

logs of P=SP*
log(P) = log(S) + log(P*)

derivatives of natural log
dp-dp*=ds

Question 6

What does Relative PPP imply about inflation and exchange rates

Answer 6

If the home country has higher inflation than the foreign country, its currency should depreciate

Question 7

What does the Balassa-Samuelson Hypothesis suggest about price levels

Answer 7

Rich countries have higher overall price levels due to higher prices in non-traded goods sectors

Question 8

How does productivity growth affect exchange rates

Answer 8

Faster productivity growth in traded goods leads to real exchange rate appreciation

Question 9

Why do PPP exchange rates often suggest developing country currencies are undervalued

Answer 9

Because the Balassa-Samuelson effect implies price levels rise with per capita income, and lower income countries have lower price levels

Question 10

When is PPP more suitable for exchange rate comparisons

Answer 10

Among developed countries and over the long run