INTERNATIONAL ECONOMICS, 7TH EDITION
Study Resources: Questions for Study & Review
Chapter 20
1. You are told that one of the reasons why PPP does not hold is the existence of tariffs
and transportation costs. Later on in the chapter you are told that these two factors
2. Assume that Malaysia, like many developing countries, has a dual economy: a vibrant
export sector where they manufacture computer components for various Japanese
companies (tradable) and a sector that produces local goods only (non-tradable).
Assume that PPP holds so their exchange rate is the ratio of their CPI over their trade
partner’s CPI, Japan.
a. What is the original value of the real exchange rate?
Then, new developments in computer technology allow Malaysia to produce the
components at lower costs.
b. What happens to wages in Malaysia’s export sector? What happens to wages
overall in Malaysia?
c. What happens to costs and prices of the non-tradable? What happens to Malaysia’s
CPI? Explain. Finally what happens to the real exchange rate?
3. When you examine series constructed on the exchange rate approach and series
constructed on the PPP approach to compare gross national income per capita, what
can you say about the dispersion for the two series? What happens to the richer
countries and what happens to the poorer countries when the level of living is
estimated with the PPP approach?
4. International Comparisons An average consumer in Canada consumes 10 pounds of
oranges, 4 loaves of bread, and 5 pints of beer. During the same period, the average
Australian consumer consumes 6 pounds of oranges, 5 loaves of bread, and 6 pints of
beer. Assume that the price of oranges in Canada is Can$2 per lb, a loaf of bread
costs Can$3, and beer costs Can$4 per pint while the corresponding prices in
Australia are respectively Aus$1 for oranges, Aus$4 per loaf, and Aus$5 for beer.
a. Use the exchange rate between the two currencies to compare their standard of
living using the Can$.
(Find the exchange rate on the Website link http://www.x-rates.com/AUD/table.html)
b. Now use the PPP approach with Canadian prices to compare their standards of
living.
c. Finally use the PPP approach with Australian prices to compare their standards of
living.
d. Comment on all three results.
5. Throughout the year in 1980, inflation in the U.S. was 13.5 percent while in the U.K. it
was 18 percent. During that same year, the exchange rate, $/£, increased from 2.225
on January 1 to 2.292 on December 31. Find this point on Figure 20.1. Does this point
meet the PPP criteria? Why or why not?
6. The central bank of Pecunia, a small country, decides to cut the money supply
permanently by 10 percent. Assume a sticky price model in the short run, where prices
eventually adjust in the long run. Explain what happens to the interest rate, the real
money supply, the price level, the expected exchange rate, and the exchange rate in
the short run. Describe the long-run adjustment for the above variables. Show all your
results using the six graphs of Figure 20.2. Elaborate about the overall movements of
the exchange rate (short run and long run) as a result of the contractionary monetary
policy.
INTERNATIONAL ECONOMICS, 7TH EDITION
Study Resources: Questions for Study & Review
Chapter 20: Answers
1. If tariffs and transportation costs were included, prices would not be equalized through
3. Two of the GNI comparisons presented in Table 20.3 are constructed with exchange
rates. With these two series, the per capita income of the richest country in the series, the
5. For relative PPP to hold, we would need to have π<minus>π* =