5 video Real exchange rate determination

Question 1

Real exchange rate? 7.4
- What does PPP infer?

Answer 1

Use the same basket of goods and determine the (aggregate) price of the basket P1 and P2 for countries 1 and 2

Real exchange rate = P1/P2

PPP infer that absolute PPP P1/P2=1
Relative PPP deltaP1/deltaP2=1

Question 2

Law of one price? 7.4

Answer 2

!!! Identical goods sold in different locations must have the same price when prices are expressed in a common currency (assuming no arbitrage opportunities)

Question 3

Reasons for PPP Failure? 7.8
Possible exam question he said

Answer 3

-Differences in production costs of goods and differences in demand
-Transport costs
-Tariffs and taxes
-Barriers to trade
-Information costs
-Differences in market power of producer
-Non-tradeables (services, like getting a haircut)

Question 4

Harrod-Samuelson-Balassa effect? .23.24

Answer 4

Productivitygrowthcomesforemostintradablegoods and much less of in non-tradables
 Developmentimpliesalargerelativeproductivityinfavour of tradables
 Itfollowsthattherealexchangerateshouldincreaseasa country grows
Countrieswithfastgrowthintradables(relativetoforeign
countries) have higher real exchange rates
 Thisisagooddescriptionoftherealexchangerate  High income countries have high real exchange rate
 Relatively faster productivity growth in tradables increases the
non-tradable prices (Example: the U.S. and Japan)
 Channel: High tradable productivity increases the country’s wage
level and that also makes non-tradables expensive. Since non- tradables are an important component of the consumption basket, the overall price level increases

Example with check republic: in the last 20years they have really strong growth in productivity of labor (associated with tradable goods, manufacturing sector), they attracted a lot of workers working for the manufacturers, Skoda for example, so now -> scarcity in the services/non-tradable goods sector. So they have to increase wages in that sector, and that led to a significant increase in the price level in the country, but that was fully matched by the productivity. If price increase would not be matched with an increase in productivity, that would be called an inflationary environment, and that is negative for the capital inflows and currency of that country.

Question 5

Firm optimisation problem, Cobb Douglas function, FOC of capital and labor. From that you can derive conclusion of Harrod Balassa effect. He said don’t focus on the derivations too much…

Question 6

Traded vs non-traded goods

Answer 6

Tradable goods and services can be sold and consumed outside of the region they are produced. In contrast, non-tradable goods and services can only be bought and consumed where they are produced. Cars and computer software are tradable. A meal at a restaurant is not

Question 7

Endogenous vs exogenous variable

Answer 7

Exogenous variables are independent, and endogenous variables are dependent. Therefore, if the variable does not depend on variables within the model, it’s an exogenous variable. If the variable depends on variables within the model, though, it’s endogenous