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Question 1 (28 marks total) Consider the economies of three countries, $\mathrm...
May 14, 2024
Solution by Steps
step 1
Identify the nominal exchange rate between AandA and B: 1 A=4 B1 \, \text{A} = 4 \, \text{B}
step 2
Identify the price of a Steak Burger in Country A: 2 A2 \, \text{A}
step 3
Identify the price of a Steak Burger in Country B: 16 B16 \, \text{B}
step 4
Calculate the real exchange rate using the formula: Real Exchange Rate=(Nominal Exchange Rate×Price in Country BPrice in Country A)=(4×162)=32 \text{Real Exchange Rate} = \left( \frac{\text{Nominal Exchange Rate} \times \text{Price in Country B}}{\text{Price in Country A}} \right) = \left( \frac{4 \times 16}{2} \right) = 32
step 5
Interpret the result: The real exchange rate of 32 means that from Country A's perspective, one Steak Burger in Country B is equivalent to 32 Steak Burgers in Country A
Answer
The real exchange rate of Steak Burger between Countries A and B is 32.
Key Concept
Real Exchange Rate Calculation
Explanation
The real exchange rate measures the relative price of goods between two countries, adjusted for the nominal exchange rate.
Part (b)
step 1
Identify the nominal exchange rate between AandA and B: 1 A=4 B1 \, \text{A} = 4 \, \text{B}
step 2
Identify the price of a Steak Burger in Country A: 2 A2 \, \text{A}
step 3
Identify the price of a Steak Burger in Country B: 16 B16 \, \text{B}
step 4
Calculate the implied price in Country B using PPP: Implied Price in B=Price in A×Nominal Exchange Rate=2×4=8 B \text{Implied Price in B} = \text{Price in A} \times \text{Nominal Exchange Rate} = 2 \times 4 = 8 \, \text{B}
step 5
Compare the implied price with the actual price in Country B: 8 B≠16 B8 \, \text{B} \neq 16 \, \text{B}
step 6
Conclude that PPP is not satisfied because the actual price in Country B is higher than the implied price
step 7
Possible reasons for PPP not being satisfied: 1. Transportation costs. 2. Trade barriers or tariffs
Answer
No, the purchasing power parity (PPP) is not satisfied. Possible reasons include transportation costs and trade barriers.
Key Concept
Purchasing Power Parity (PPP)
Explanation
PPP suggests that in the absence of transaction costs and barriers, identical goods should have the same price when expressed in a common currency.
Part (c)
step 1
Given that the Steak Burger is the only final good produced and consumed in Countries A and B, and the price in Country B is higher than in Country A, the nominal exchange rate is likely to adjust
step 2
Predict that the nominal exchange rate will change to reflect the price difference, likely leading to an appreciation of AoradepreciationofA or a depreciation of B
step 3
Conclude that the nominal exchange rate between AandA and B will likely decrease in the future
Answer
The nominal exchange rate between AandA and B will likely decrease in the future.
Key Concept
Exchange Rate Adjustment
Explanation
When there is a price difference for the same good between two countries, the exchange rate tends to adjust to reflect this difference.
Part (d)
step 1
If the Steak Burger is only one out of thousands of final goods produced and consumed in Countries A and B, the impact on the nominal exchange rate will be less significant
step 2
The exchange rate will be influenced by the prices of all goods, not just the Steak Burger
step 3
Conclude that the nominal exchange rate may not change significantly if the Steak Burger is only one of many goods
Answer
The nominal exchange rate may not change significantly if the Steak Burger is only one of many goods.
Key Concept
Diverse Goods Impact on Exchange Rate
Explanation
When multiple goods are considered, the exchange rate reflects the overall price levels rather than the price of a single good.
Part (e)
step 1
Given the real output growth and money supply increase for Countries A and B: - Real output growth: 8% (A), 12% (B) - Money supply increase: 10% (A), 30% (B)
step 2
Use the formula for the nominal exchange rate change: Nominal Exchange Rate Change=(1+Money Supply Increase in B1+Money Supply Increase in A)×(1+Real Output Growth in A1+Real Output Growth in B) \text{Nominal Exchange Rate Change} = \left( \frac{1 + \text{Money Supply Increase in B}}{1 + \text{Money Supply Increase in A}} \right) \times \left( \frac{1 + \text{Real Output Growth in A}}{1 + \text{Real Output Growth in B}} \right)
step 3
Substitute the given values: Nominal Exchange Rate Change=(1+0.301+0.10)×(1+0.081+0.12)=(1.301.10)×(1.081.12) \text{Nominal Exchange Rate Change} = \left( \frac{1 + 0.30}{1 + 0.10} \right) \times \left( \frac{1 + 0.08}{1 + 0.12} \right) = \left( \frac{1.30}{1.10} \right) \times \left( \frac{1.08}{1.12} \right)
step 4
Calculate the result: Nominal Exchange Rate Change=1.1818×0.9643=1.1404 \text{Nominal Exchange Rate Change} = 1.1818 \times 0.9643 = 1.1404
step 5
Conclude that the nominal exchange rate will increase by approximately 14.04%
Answer
The nominal exchange rate between AandA and B will increase by approximately 14.04%.
Key Concept
Nominal Exchange Rate Adjustment
Explanation
The nominal exchange rate adjusts based on changes in money supply and real output growth in the respective countries.
Part (f)
step 1
Given that all three countries trade with each other and have defined exchange rates, it is likely that they are open economies
step 2
Open economies engage in international trade and have exchange rates that facilitate this trade
step 3
Conclude that it is possible that all three economies are open economies
Answer
Yes, it is possible that all three economies are open economies.
Key Concept
Open Economies
Explanation
Open economies engage in international trade and have exchange rates that facilitate this trade.
Part (g)
step 1
Given the investment in foreign assets and foreign investment in Country C's assets: - Investment in foreign assets: 2500 C2500 \, \text{C} billion (beginning), 2700 C2700 \, \text{C} billion (end) - Foreign investment in Country C's assets: 3200 C3200 \, \text{C} billion (beginning), 3150 C3150 \, \text{C} billion (end)
step 2
Calculate the net capital outflow: Net Capital Outflow=(End Investment in Foreign Assets−Beginning Investment in Foreign Assets)−(End Foreign Investment in Country C−Beginning Foreign Investment in Country C) \text{Net Capital Outflow} = (\text{End Investment in Foreign Assets} - \text{Beginning Investment in Foreign Assets}) - (\text{End Foreign Investment in Country C} - \text{Beginning Foreign Investment in Country C})
step 3
Substitute the given values: Net Capital Outflow=(2700−2500)−(3150−3200)=200+50=250 C billion \text{Net Capital Outflow} = (2700 - 2500) - (3150 - 3200) = 200 + 50 = 250 \, \text{C} \, \text{billion}
step 4
Conclude that the net capital outflow is 250 C250 \, \text{C} billion
step 5
Since net capital outflow equals net exports, the net export of Country C is also 250 C250 \, \text{C} billion
Answer
The net capital outflow and net export of Country C for this year are both 250 C250 \, \text{C} billion.
Key Concept
Net Capital Outflow and Net Export
Explanation
Net capital outflow represents the difference between a country's investment in foreign assets and foreign investment in the country's assets, and it equals net exports.
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