IMF Chapter 6

Question 1

How does Balassa-Samuelson explain that the Prich > S P*poor?

Answer 1

1. productivity higher in rich
2. Wages in tradable are higher
3. Wages in non tradable are higher
4. Prices in non-tradable are higher

Question 2

What is the Law of one Price?

Answer 2

Products listed in different currencies are equal if converted due to arbitrage

Question 3

How does PPP define the exchange rate?

Answer 3

S = Pg / P*g

Question 4

What is the definition of the Purchasing Power Parity (PPP)?

Answer 4

If LOP then P = S x P*

Question 5

What is the are the Absolute and Relative PPP?

Answer 5

1. Absolute PPP: P = S x P*
2. Relative PPP: dP/P = dS/S + dP/P

Question 6

What is the link between relative PPP and inflation?

Answer 6

If we turn the formula round we get dS/S = dP/P - dP/P, is the excess inflation between H over F

Question 7

Do the Absolute and Relative PPP always hold?

Answer 7

If the Absolute PPP holds, then so does the Relative PPP, but vice versa NO

Question 8

What does Balassa-Samuelson explain?

Answer 8

Using empircal observation that the price level is higher in rich countries because of higher productivity in the tradables sector

Question 9

What are the reasons for deviations from the PPP?

Answer 9

1. Trade costs and impediments
2. tradeables vs non-tradeables
3. Productivity differentials (Balassa -Samuelson)

Question 10

How do we calculate under and overvaluation?

Answer 10

Calculate exchange rate according to LOP, Sg = Pg / Pg* and then calculate under/overvaluation via S-Sg / Sg