If the law of one price holds, then the exchange rate must equal the ratio of the goods' prices expressed in the two currencies: E$/€ = PgUS/PgEUR, where PgUS is the good's price in the United States, PgEUR is the good's price in Europe, and E$/€ is the dollar- euro exchange rate. If the law of one price holds, what is the E$/€, the dollar- euro exchange rate? E$/€ = 1.35 (5.5% − 2.5% = 3%) An iPod costs € 46 in Frankfurt and $62 in San Francisco. What is the nominal interest rate? 5.5%Įxpected inflation is the difference between the nominal interest rate and the world real interest rate. Expected inflation is 3% and the world real interest rate is 2.5%. A country implemented a nominal anchor policy. Between 19, the relationship between the rate of inflation and the money supply growth rate: was positive. Which of the following functions of money does this illustrate? Money is a store of value because, as with any asset, money held from today until tomorrow can still be used to buy goods and services in the future. Monte saves $100 today in his bank account, and he plans on spending it next year. (€ 200 } (1.35 $/€) = $270.00) Using subscripts to indicate locations and currencies, the relative price of good g can be written thus: qgUS/EUR = (E$/€ PgEUR)/PgUS, where PgUS is the good's price in the United States, PgEUR is the good's price in Europe, and E$/€ is the dollar- euro exchange rate. The law of one price states that in the absence of trade frictions (such as transport costs and tariffs) and under conditions of free competition and price flexibility (no individual seller or buyer has the power to manipulate prices and prices can freely adjust), identical goods sold in different locations must sell for the same price when prices are expressed in a common currency. If the exchange rate is $1.35 per euro and the law of one price holds, how much will the iPhone cost in San Francisco? about $270 This is an example of which nominal anchor? exchange rate targetĪn exchange rate target sets the rate of currency depreciation. A country implemented a policy that set the fixed rate of currency depreciation to zero. Md/P represents the demand for real money. Y, what does Md/P represent? the demand for real money.In the demand for real money balances equation in the general model, Md/P = L(i) Furthermore, purchasing power parity implies that the exchange rate and price level must move in the same proportion. According to the monetary approach, a 15% increase in the money supply leads to: a 15% increase in the exchange rate.Īssuming real money balances remain constant, money supply and price must move in the same proportion. According to the fundamental equation of the monetary approach to exchange rates, what happens to the dollar-euro exchange rate if the U.S. If qUS/EUR falls, the United States has experienced a real appreciation. goods are needed to exchange for foreign goods. If the real exchange rate qUS/EUR falls: it takes fewer U.S.
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