Explore BrainMass
Share

purchasing-power-parity theory of exchange rates

This content was STOLEN from BrainMass.com - View the original, and get the already-completed solution here!

1. "A rise in the dollar price of yen necessarily means a fall in the yen price of dollars." Do you agree? Illustrate and elaborate: "The critical thing about exchange rates is that they provide a direct link between the prices of goods and services produced in all trading nations of the world." Explain the purchasing-power-parity theory of exchange rates.

2. Explain why the U.S. demand for Mexican pesos is downward-sloping and the supply of pesos to Americans is upward-sloping. Assuming a system of flexible exchange rates between Mexico and the United States, indicate whether each of the following would cause the Mexican peso to appreciate or depreciate:
a. The United States unilaterally reduces tariffs on Mexican products.
b. Mexico encounters severe inflation.
c. Deteriorating political relations reduce American tourism in Mexico.
d. The United States' economy moves into a severe recession.
e. The U.S. engages in a high interest rate monetary policy.
f. Mexican products become more fashionable to U.S. consumers.
g. The Mexican government encourages U.S. firms to invest in Mexican oil fields.
h. The rate of productivity growth in the United States diminishes sharply.

3. "The United States can produce product X more efficiently that can Great Britain. Yet we import X from Great Britain." Explain.

4. What is offshoring of white-collar service jobs, and how does it relate to international trade? Why has it recently increased? Why do you think more than half of all of the offshored jobs have gone to India? Give an example (other than that in the textbook) of how offshoring can eliminate some U.S. jobs while creating other U.S. jobs.

© BrainMass Inc. brainmass.com October 16, 2018, 7:35 pm ad1c9bdddf
https://brainmass.com/economics/economic-growth/purchasing-power-parity-theory-of-exchange-rates-120938

Solution Preview

1. "A rise in the dollar price of yen necessarily means a fall in the yen price of dollars." Do you agree? Illustrate and elaborate: "The critical thing about exchange rates is that they provide a direct link between the prices of goods and services produced in all trading nations of the world." Explain the purchasing-power-parity theory of exchange rates.
Yes I agree with this as if there is an appreciation of first currency with relation to the second currency. Thus it means that there is depreciation in second currency with relation to the first currency.
Hence here if yen is rising then there is a fall in dollar with relation to each other.
For example if
1 US $ = 100 Yen than , 1 Yen= .01US$
Now if Yen rises,
1 Yen= .011 US$, 1 US $ = 90 Yen,
than there is fall in value of Dollar

Explain the purchasing-power-parity theory of exchange rates.

Purchasing power parity (PPP) is a method used to calculate an alternative exchange rate between the currencies of two countries. The PPP measures how much a currency can buy in terms of an international measure (usually dollars), since goods and services have different prices in some countries than in others.

PPP exchange rates are used in international comparisons of standard of living. A country's GDP is originally tallied in its local currency, so any comparison between two countries requires converting currency. Comparisons using real exchange rates are considered unrealistic, since they do not reflect price differences between the countries. The differences between PPP and real exchange rates can be significant. For example, GDP per capita in China is ca. 1,400 U.S. Dollars, while on a PPP basis, it is 6,200 US$. At the other extreme, Japan's nominal GDP per capita is 37,600 US$, but its PPP figure is only 31,400 US$.

2. Explain why the U.S. demand for Mexican pesos is downward-sloping and the supply of pesos to Americans is upward-sloping.

Foreign exchange refers to money denominated in the currency of another country. This market is essentially governed by the law of supply and demand and is generally not regulated by any government or coalition of governments. This is ...

Solution Summary

The purchasing-power-parity theory of exchange rates is defined.

$2.19
Similar Posting

Theory of Purchasing Power Parity: Exchange and Interest Rates, USD vs Euros

Congratulations, you just won the Irish Lottery! You bought a ticket while you were on vacation in Ireland, and you just won a 1 million Euro jackpot after all taxes were taken out.

1. If the current exchange rate is US$1 equals 1.25 Euros, how much did you win in US dollars?
2. Suppose that the interest rate in Irish banks is 5% for a one year CD. In the USA, the rate is 2% for a one year CD. If you left your winnings in Ireland, how many Euros would you have in a year? If you had taken your winnings back to the USA, how many dollars would you have?
3. Suppose when you cashed in your CD in Ireland a year from now, the exchange rate had changed from US$1 to 1.25 Euro, to US$1 to 1.30 Euro. How much would your Irish bank account be worth in US$ at that point? Did you do better off leaving your winnings in Ireland or bringing them home to the USA?
4. Explain how banks and individuals can use "covered interest arbitrage" to protect themselves when they make international financial investments.
5. Using the theory of purchasing power parity, explain how inflation impacts exchange rates. Based on the theory of purchasing power parity, what can we infer about the difference in inflation between Ireland and the USA during the year your lottery winnings were invested?

View Full Posting Details