The Purchasing Power Parity

Question 1

is a theory which states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two
countries.

Answer 1

Purchasing power parity (PPP)

Question 2

means that the exchange rate between two countries should equal the ratio
of the two countries’ price level of a fixed basket of goods and services.

Answer 2

PPP Theory

Question 3

When a country’s
domestic price level is _____ (i.e., a country experiences inflation), that country’s exchange rate must ______ in order to return to PPP.

Answer 3

increasing; depreciated

Question 4

The basis for PPP is the

Answer 4

“law of one price”

Question 5

In the absence of ______ competitive markets will equalize the price of an identical good in two
countries when the prices are expressed in the same currency.

Answer 5

transportation and other
transaction costs

Question 6

How is PPP calculated

Answer 6

compare the price of a “standard” good that is in fact identical across countries.

Question 7

________ publishes a light-hearted version of PPP: its “Hamburger
Index” that compares the price of a McDonald’s hamburger around the world.

Answer 7

The Economist magazine

Question 8

In the long run, the exchange rate between a pair of countries is determined by the_______ within each country.

Answer 8

relative purchasing power of currency

Question 9

Two currencies are at purchasing power parity when a ________ can buy the same basket of goods at home or abroad.

Answer 9

unit of domestic currency

Question 10

The _______ of two currencies is measured by the real exchange rate.

Answer 10

relative purchasing power

Question 11

is the ratio of foreign to domestic prices, measured in the
same currency.

Answer 11

real exchange rate

Question 12

It measures a country’s competitiveness in international trade.

Answer 12

real exchange rate

Question 13

The real exchange rate, R, is defined as

Answer 13

R = ePf/P

Question 14

R = ePf/P

Answer 14

P and Pf = the price levels here and abroad;

e = the peso price of a foreign exchange

Question 15

R = ePf/P

the numerator expresses _____

Answer 15

prices abroad measured in pesos

Question 16

R = ePf/P

the denominator is the ______ which expresses prices abroad relative
to those at home

Answer 16

domestic price level

Question 17

If the ________, currencies are at purchasing power parity.

Answer 17

real exchange rate equals 1

Question 18

A ___________ means that goods abroad are more expensive than goods at home.

Answer 18

real exchange rate above 1

Question 19

Other things equal, this implies that people – both at home and abroad – are likely to switch
some of their spending to goods produced at home.

Answer 19

increase in
the competitiveness of our products.

Question 20

“Purchasing power parity exchange rates, or PPPs, are price indexes that summarize
prices in each country relative to a numeraire country, typically the United States.

Answer 20

Angus Deaton